After number of very strong years, equities are now being described as virtually fully priced.

But with interest rates and bond yields still low, investors who move their portfolio into income-producing assets instead are faced with returns that are not high enough to meet their requirements.

Peter Lynn, of Nikko NZ, said the solution could be to consider alternative investments.

“They’re often cast out as incredibly risky. But we’ve invested in a fund of hedge funds managed by JP Morgan since 2001. With the exception of cash, it’s the most consistent investment we have. It invests in 40 different hedge funds and each may be doing something that is quite volatile and quite risky but they’ve got their due diligence and risk analysis process down so well that they can package those 40 risky investments together and have a very nice, smooth outcome.”

Nikko NZ’s balanced fund had a large weighting, currently 20%, to alternative assets, Lynn said. “That I think is a more sensible solution than trying to go really defensive. It should be diversified.”

Investors should not be encouraged to give up their equities at this stage, even if they thought they were fully valued, he said. Global moves such as the European Central Bank’s qualitative easing would support the markets for some time yet.

“Almost every week there’s another record high and you don’t want to miss out too much on that. But you need to have those defensive assets for when things do go south... But the expected return you’re getting out of those income assets is very low. You need other things that are not correlated to equities or bonds that are going to produce a reasonable return, mitigate the risk of an equity market fall or bond yield rise. This is the perfect time for alternative investments.”

He said active managers would be given a chance to shine when equity markets finally came off the boil. “Equity values may not rise much more but there are a number of stocks globally that are underpriced. It’s up to a good manager to find those and pick them out.”

While passive managers did well in a strong market, he said a good active manager should be able to mitigate a downside to the market, by finding underappreciate stocks that were not going to fall and might have further room to rise. 

“It’s turning into a stock-picker’s market," Lynn said.