Jack Lin of Pioneer Investments
Concerns over the outlook for returns from equities and bonds, combined with a potential rise in volatility, has led to a major rethink of portfolio construction. We believe that many of the world’s most conservative investors are actually invested in some of the riskiest assets. In our opinion, the returns and diversification benefits previously provided by bonds are unsustainable going forward and investors have become over-reliant on the growth of equities.
The ability to generate true alpha has become a crucial element in the asset allocation process and a much wider focus on diversification is now required. The days of a traditional 60/40 split between equities and bonds could well be over. Maintaining this allocation between the traditional asset classes of equity and bonds may not produce the steady returns that investors have come to expect.
In our opinion, investors may need to examine traditional allocations and consider differentiated ways to generate returns. Efficiently integrating liquid alternatives that explore unique, uncorrelated alpha opportunities into portfolio construction can allow for enhanced diversification and low correlations to the broader markets.
In the aftermath of the global financial crisis (GFC) in 2008, investors now place over-riding value on liquidity, transparency and control. Yet liquid alternatives investors are actually benefiting from different sources of returns and improved risk-adjusted performance via differing investment techniques. By allocating a portion of a traditional balance portfolio exposure to liquid alternatives, which have the potential to generate attractive returns independent from prevailing economic conditions, investors may experience the potential for more stable and higher risk-adjusted returns over time.
Liquid alternative strategies have the ability to offset an investor’s beta exposures during periods of declining market returns, which may allow them to contain the drawdowns experienced within both equity and bond markets. Investors may benefit from opportunities that traditional investment strategies are unable to explore, while possibly reducing the overall market sensitivity of their portfolio during periods of market stress and potentially mitigating the downside.
Since the GFC, and given the asset price appreciation effects of quantitative easing, some investors have been disappointed on a relative basis, with the absolute return of non-traditional mutual fund strategies versus traditional investments (see graph). From a top-line performance perspective, the alternative industry has delivered relatively muted numbers, but this does not take into account the risk-adjusted contribution. Indeed, it can take extreme events, such as the market turbulence resulting from Chinese equity markets in August 2015, to show the true qualities of non-traditional investment strategies.
Overall, liquid alternatives achieved their goal in this sell-off period. After all, these non-traditional mutual funds are supposed to provide attractive risk-adjusted returns with low correlation to traditional equity and bond markets. Although Ucits-compliant non-traditional mutual funds posted declines in August, the -2.5% return for the HRFU Hedge Fund Composite Index was relatively muted, compared to the -11.1% fall in the S&P 500 Index during the same period.
At Pioneer Investments, we systematically hedge against tail risk and have increased the use of non-directional relative-value plays aiming to deliver more alpha. The process places a huge focus on risk management. We know target returns are important, but we believe investors also seek downside management. Rethinking asset allocation by mixing traditional and non-traditional liquid assets in a framework that places risk management at its heart is vital.
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Important Information: Unless otherwise stated all information and views expressed are those of Pioneer Investments as at 9 February 2016. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested.
Pioneer Investments is a trading name of the Pioneer Global Asset Management SpA group of companies.
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