With the S&P 500 and FTSE 100 indices trading near all-time highs and some peripheral European sovereign bonds yielding less than US and German government debt, multi-asset managers are under pressure to seek assets with low correlation to equities and bonds.
But to what alternative asset classes are managers turning?
John Husselbee, Liontrust head of multi-asset says: “The definition of alternatives is wide, but we would include both non-traditional asset classes, such as commodities and non-traditional investment strategies, such as long/short equity.
“The commonality is liquidity, which can dilute the diversification benefits of some investments in this category.”
Siu Kee Chan, an investment manager at ING Investment Management, says combining real estate and commodities in a portfolio next to equities and bonds can make sense, but he is “less convinced about investing in commodities on a structural basis”.
Toby Nangle, Threadneedle Investments’ head of multi-asset allocation, says that while physical commodities typically have a very low correlation to equities and bonds, during the financial crisis correlations rose meaningfully.
However, he says in recent months the correlation characteristics of old have begun to re-emerge, and he has been making greater use of commodities where investment mandates permit.
“Commercial property is another asset class that over the medium-term typically exhibits low levels of correlation to equities and bonds,” he explains.
“In a liquidity crisis, we would expect correlations to rise, but at present, we see a decent risk premium on offer that attracts us to property.”
Richard Batty, Invesco Perpetual multi-asset fund manager, says his multi-asset funds use asset classes such as foreign exchange and volatility.
While these assets can increase the diversification benefits in a portfolio, Mr Batty says what is more pertinent is the quality of the “ideas” that are put in a portfolio, irrespective of asset class label.
For example, he says being long large-cap US equity futures, such as the S&P 500 index, while at the same time being short small-cap US equity futures via the Russell 2000 index, can provide big diversification benefits for a portfolio.
“Here we believe large-cap stocks are cheap relative to their small-cap equivalents, and are pricing in a relative profits outlook that is too pessimistic,” he claims.
“Also, stockmarket and foreign exchange volatility is being priced too low across a number of geographies, such as in Asia, opening up opportunities for us to buy volatility through a number of our ideas in the portfolio.”
Elizabeth Savage, who works on Rathbone Unit Trust Management’s multi-asset funds, looks to equity long/short and non-directional active-managed fixed income to diversify portfolios. This includes using funds such as Henderson UK Absolute Return and Ignis Absolute Return Government Bond.
L&G multi-asset manager Justin Onuekwusi favours real estate, but prefers bricks and mortar as a diversifier rather than property securities or real estate investment trusts (Reits), because direct property provides lower correlation to traditional asset classes.
So how much exposure do multi-asset managers have to these asset classes? Mr Husselbee says the proportion invested in alternative assets varies from one portfolio to another, but would consider a fifth of the portfolio exposed to alternative assets in a well-diversified, low risk portfolio as an acceptable weighting.
Mr Kee Chan says benchmark allocation to real estate is roughly 5 per cent, while Mr Nangle has portfolios with more than 20 per cent exposure to commercial property.
Invesco’s Mr Batty says targeting exposure to asset classes is not necessarily the best way to create a diversified portfolio, preferring ideas that can provide a positive return in all market conditions.
“Understanding the likely losses from each idea is also key to creating a robust portfolio,” he adds.
Mr Onuekwusi’s risk-targeted funds currently have 5-10 per cent exposure to direct property, depending on the risk profile.
“This is a core position for us, so we aren’t looking to build up a specific weighting from current levels,” he says.
So are multi-asset managers seeking new asset classes for their portfolios?
Mr Husselbee says changing regulation and product development has sparked the growth in alternative offerings, citing long/short and market-neutral offerings in the equity space. Meanwhile, in fixed interest and currency, unconstrained funds “in many flavours” are fulfilling a need for uncorrelated bond and equity returns.
Mr Nangle, however, is deeply sceptical as to how ‘new’ these so-called new asset classes really are, and says buying them typically entails exposing clients to enhanced liquidity risk.
“Our existing investment processes operate with a range of assets, from emerging market local debt, to developed market equity, to the full spectrum of credit bonds, to property, physical commodities and currency,” he explains.
“We must be careful that we understand how any new asset classes we add to this mix will integrate at a portfolio level.”
Mr Batty sums up the feelings of many multi-asset managers: “Rather than investing in ‘new’ asset classes, making sure that each of the ideas in a portfolio is appropriately risk-sized for the macro outlook in the next two to three years is key.”
