Partner Content by 7IM

Why pay the government for lending them money? Instead, look for alternatives

As we all know, March saw equity markets tumble globally in a matter of weeks. Not too surprising. Unfortunately, every now and again equity markets fall sharply. The astonishing thing for me was that:

  1. I was watching markets move from screens perched on my dining table in Clapham
  2. At the peak of the equity drawdown, government bonds were falling in value at the same time

The first of those was not too much of a problem; I’d brought a posh coffee machine shortly before lockdown and technology made working from home relatively seamless. On the other hand, the second of those is a big problem for the “free lunch” that multi asset portfolios are built upon - diversification. Traditional balanced portfolios usually aim to deliver diversification by mixing equities for growth and bonds for their defensive properties.

When bonds fell at the peak of the equity selloff, it was hardly the defence many would have hoped for. However, as well as being expected to rise when equities fall, investors in bonds historically could have relied on a yield income as an extra layer of defence. Given market movements over the last few months and years though, investors in most UK government bonds (Gilts) now receive hardly any income at all. Even worse, the yield on some Gilts has joined those in Europe and Japan by hitting negative territory. In some cases, you now have to pay the UK government for the honour of lending them money.

Now, unless you really went big on eating out in August and find yourself feeling guilty about all those half price dinners and want to give something back to the government, many bonds now look like a fairly unattractive investment. 2020 has provided the proof that investors must now, surely, look further afield for diversification.

So where to look? At 7IM we have long been believers that alternative assets are part of the answer. However, this category of investments is vast, and some come complete with all the characteristics you should definitely look to avoid where possible; high fees, illiquidity and complexity.

Our alternatives selection process is focussed on identifying assets that provide the sort of diversification that bonds historically offered portfolios, without the downsides listed above. In practice that means avoiding things like direct property, fine art, wine and instead focussing on strategies in more liquid markets (no pun intended). 

At 7IM, our “other” basket is composed of global real estate investment trusts (REITs) and a mix of liquid alternative strategies. The REITs offer diversification, liquidity and growth through exposure to the global property cycle. The liquid alternative strategies allocation, constructed by us, brings defensive characteristics to portfolios, whilst still providing returns above inflation. 

Our liquid alternatives strategies also include assets such as a commodity “long short” strategy. This strategy buys and sells commodity contracts for delivery at different points in time in the future. This is one example of an asset that did very well at the start of the year. When commodity markets plummet, demand for commodities dries up. In this particular example, that meant oil tankers were filling up.  In April this year, oil prices went negative. Companies literally had to pay others to take oil off their hands - they had nowhere left to store it! For the first three months of 2020, this commodity “long short” strategy made almost 30% through selling those contracts that were falling most. This type of strategy is invested in liquid markets meaning it is low cost to implement, and is an example of the assets we like to hold within our alternatives allocation.