Investors are entering a period of prolonged higher risk where market volatility will return as a long-term feature, according to research house van Eyk.

Van Eyk’s Strategic Asset Allocation (SAA) Review, released today (November 8) predicts that some traditional safe havens will hide unexpected dangers and alternatives assets will remain an important diversification tool.

The review sets out van Eyk’s recommended long-term asset allocation for investors over the next three to five years.

Van Eyk head of research, John O’Brien, defends benchmarking investment strategies and says a relatively high exposure to alternative assets should continue to offer superior risk-adjusted returns over the next three to five years.

He points out that volatility has been the norm over the very long term with the relative stability of the past decade the exception.

“Investors should seek to diversify their sources of risk, and this is reflected in our portfolio construction,’’ O’Brien says. “They should look for pockets of growth, without chasing the latest hot market.”

Despite forecasting a volatile road ahead for equity markets, van Eyk maintains a relatively high exposure to stocks in its SAA balanced portfolio because it considers them relatively cheap and as having tax advantages.

However, in the shorter term, van Eyk’s research team disputes the consensus view that developed market equity earnings will grow by 10 per cent in 2012 as “too optimistic”.

“Although equities face near term headwinds they are attractively priced on a long term basis,” O’Brien says.

Van Eyk recommends an Australian equities portfolio allocates 63 per cent to large cap stocks, 7 per cent to small caps, and 30 per cent to absolute return strategies.

The review said equity markets in the developed world have entered a “Snow White” period where the returns will be relatively low for the next few years but will be kept alive by continued strong, if volatile, growth from emerging countries, particularly China.

It also warns investors to remain on guard for a breakout in inflation, which has been kept in check since the global financial crisis (GFC).

Inflation is a threat to fixed interest investments, which have become fashionable again after strong returns since the GFC.

Van Eyk warns that fixed interest remains a tricky asset class to get right and says the strong returns since the beginning of the GFC are a potential trap for those who expect the next few years to offer the same.

The investment research house recommends a much lower allocation to fixed interest in a balanced portfolio -18 per cent – than many other asset allocators.

“Investing in alternative assets will also be an important diversifier since some traditional markets are becoming more highly correlated because of increased globalisation,” the review concludes.

“Australian equities, for example, have become more highly correlated with international equities while real estate investment trusts, traditionally defensive assets, have become more highly correlated with the broader equity market.”