Across institutional and retail investment mandates, the concept of using just bonds and equities to construct a diversified portfolio is on the way out. Managers and advisers are conscious that a basic 60/40 portfolio is likely to provide neither the growth, yield nor the diversification required for a modern day investor.
In its place has come a raft of new asset class options, many of which were developed for long-term and large-scale institutional investors before being made available to smaller investors. Alternative assets, as a concept, can be defined as anything from property to multi-asset absolute return strategies and far beyond.
As a rule, alternatives should retain a common characteristic: they must be relatively uncorrelated to equity and fixed income. But they can have different fundamentals in terms of liquidity, suitable investment time horizon or other criteria.
To most, alternative assets mean exposure not only to property, but also infrastructure, specialist debt, private equity and hedge funds.
The Personal Investment Management & Financial Advice Association’s (Pimfa) private investor index series has a 17.5 per cent allocation to alternatives in its conservative investor benchmark – higher than the 10 per cent allocated to government bonds and the 5 per cent allocated to real estate.
This index series highlights one of the biggest issues for discretionary managers and advisers – how to measure performance. Given that asset classes such as private equity, hedge funds and specialist debt are not accessed via public markets, the concept of a benchmark return is difficult one to ascertain. Such a restriction has turned off portfolio managers due to the need to compare relative returns.
One requirement for the series is its benchmarks must be 100 per cent investable. That means MSCI’s alternatives benchmark is an equal split between 1-week Libor (GBP) and the MSCI World Diversified Multi-Factor index. According to MSCI, this combination mimics the volatility and returns of a basket of alternatives.
According to Steve Kowal, MSCI executive director, the measurement received “broad-based consensus” from the wealth management community despite its inability to physically match assets.
Mr Kowal says: “The index delivers the return and volatility metrics of alternatives. [We could] try to recreate an index using all the alternative asset classes, but it would not be investable and you would not be able to use hedge funds. It’s not an easy thing to do. It depends on the view of what is ideal, but there is no consensus on what is ideal.”
Despite complications over how to measure and access alternatives, their usefulness within a portfolio is unquestionable in terms of diversification. Increasing access to closed-ended vehicles for retail investors is opening up access to more esoteric investments.
Specialist debt is an asset class favoured by many of these trusts. The area, as measured by the Citi WorldBIG Collateralised ABS index, shares only a 0.1 correlation with the MSCI World index, but can move in line with mainstream bond markets.
Elsewhere, private equity is positively correlated to global equities to the tune of 0.67, but its correlation to fixed income is 0.1. The HFRI Fund of Funds Composite hedge fund index shares only a 0.43 correlation with global equities, but is highly correlated to fixed income markets.