Asset AllocatorJan 24 2019

Alts prove their worth for wealth firms - but 60/40 portfolios show signs of life

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Proving their worth?

The leading lights of the alternatives arena didn’t cover themselves in glory last year. Hedge fund strategies had a dismal October in particular, and many DFMs simply ran out of patience with their former absolute return favourites. But the sheer scope of the options available to discretionaries means there are plenty of other choices for those looking to diversify their portfolios.

We should also bear in mind that the fourth quarter was a brutal one for all sorts of assets - and set against this backdrop, diversifiers did prove their worth. Below, we’ve used our fund selection database to compare DFMs’ alternative picks against the average performance of traditional fund sectors in the fourth quarter.

As this shows, the likes of long/short funds comfortably outperformed long-only equity strategies. Hedge funds outstripped even the more cautious mixed asset funds, and so too did much-maligned multi-asset absolute return products.

Dig a little deeper and you can see the dispersion of returns is much greater among alternatives, however. The typical fund may have done better, but the alts space was also home to major strugglers such as Polar Capital UK Absolute Equity or Aspect Diversified Trends.

Speaking of the latter, it’s also interesting to note that many DFM hedge fund favourites did protect portfolios much better in the final month of the year than at the start of the quarter: the Aspect fund shed 1 per cent in December compared with 11 in October, Dunn’s WMA strategy made 3 per cent versus an earlier loss of 7 per cent, and Marshall Wace Tops was also in the black having shed 4.2 per cent in October.

But there is one area where alternatives haven’t really helped. No absolute return bond strategy did particularly poorly in the fourth quarter, but as a whole this type of fund wasn’t able to keep up with the average corporate bond pick. That may be because it wasn’t a disastrous quarter for fixed income - nonetheless, DFMs may want to ponder whether short duration or even conventional strategies are more effective than their more complicated peers.

60/40 set fair?

Speaking of traditional bond funds, the calmer markets seen this month have prompted a defence of the old 60/40 portfolio from some quarters. 

It was only a few months ago that such strategies came under renewed attack, courtesy of a paper published by KKR and a research note from Goldman. Both spoke of the need to recognise that correlations between different assets aren’t static, and doubtless they're sticking to those assertions. But a reassertion of the inverse correlation between shares and treasuries at the end of last year has got many US asset managers thinking again.

The belief is that investors' biggest fear - a slowdown in growth - would hurt equities but help bonds, particularly now the Fed’s hiking cycle looks to be taking a breather. BlackRock’s US fixed income team is among those to predict that 60/40 funds will have a better 2019 thanks to normalising correlations.

You can argue that this shift in mindsets is little more than a response to short-term price action - and fails to acknowledge the KKR/Goldman point about the risk of a speedy breakdown in correlations. By the same token, the belated alarm voiced last year was also a reaction to how such portfolios had struggled during 2018.

But even if negative correlations do persist this year, wealth managers have firmly staked their case on the need for more diversified portfolios. That looks sensible: there will come a point where bonds and equities struggle in tandem again. And besides, the relationship between US shares and US treasuries is far from guaranteed to apply in other fixed income markets closer to home.

Robo reaction

Fans of our “What we're reading” links may have taken interest, earlier this week, in an unusual experiment in the D2C investment space. Holly Mackay, of personal finance site Boring Money, gave 22 different platforms and robo-advisers £500 each to invest for the duration of 2018.

It’s no surprise that all of them lost money in a tough year, but the difference in outcomes was significant, with £120 between the best and worst off. Much of this is down to the fees being charged, but tactical asset allocation also played a role: the top three performers all substantially reduced their equity exposure over the year.

Needless to say, this kind of data has relevance for traditional wealth managers, too. As our own data shows, asset allocation has become a major dividing line for DFMs when it comes to their core portfolios. US equities are one example of this, as are the more defensive parts of a wealth manager’s arsenal.

Those decisions are going to become more important as the simple task of producing a positive return becomes more difficult - particularly as Mifid II disclosures will also have a role to play in how clients perceive porfolios this year. The good may well flourish, but the strugglers will risk falling by the wayside, and DFMs will be increasingly conscious of those pressures as 2019 continues.