Building a defensive portfolio at a time of heightened volatility

  • To understand the correlation between bonds and equities.
  • To discover how some of the alternatives perform at times of heightened volatility.
  • To understand how bonds are impacted by economic volatility.
  • To understand the correlation between bonds and equities.
  • To discover how some of the alternatives perform at times of heightened volatility.
  • To understand how bonds are impacted by economic volatility.
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CPD
Approx.30min
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CPD
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CPD
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Building a defensive portfolio at a time of heightened volatility
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The starting point is to seek out investments that we believe will have a low sensitivity to the broader economy, which tends to lead us to alternative asset classes and to using derivatives to structure investments with low correlation to the more traditional parts of the market, such as equities and bonds.  

This helps us remain defensive when financial markets experience periods of high volatility usually associated with drawdowns.    

Alternative thinking?

Our approach is built around a core of defensive bond alternatives that offer the potential of attractive risk-adjusted returns versus the broader fixed income universe. These are investments with bond-like characteristics that tend to have a relatively short maturity profile and low sensitivity to broader market moves.  

As an example, the fund invests in a portfolio of zero-dividend preference shares, which is an area where we continue to find what we perceive to be better opportunities than can be found in the bond market. 

ZDPs are debt instruments issued by companies, often investment companies, which do not pay a coupon but, at maturity, return the initial capital plus total accrued interest. 

Our analysis has led us to believe that their credit quality is high. Despite this, the ZDP portfolio is offering gross redemption yields similar to that of high-yield bonds with similar maturities and significantly more than the return that UK gilts or AAA-rated UK corporate bonds would provide.

The specialist nature of the sector, the low maturity profile and the return premium relative to other sectors of the fixed income universe, have insulated the fund’s ZDP portfolio to the volatility experienced in the bond market so far this year.

We also have an allocation to alternative investments, which we think of as investments outside of the more conventional asset classes of equities and bonds. 

Traditionally, the largest alternative asset classes have been hedge funds, real estate, infrastructure and private equity, but in recent years the range of opportunities, and how you can access those, has widened significantly. Examples of new asset classes we have recently gained exposure to include music royalties, energy efficiency projects and digital infrastructure.

 Diversification is the primary risk management tool available to multi-asset funds.

The performance of alternative investments tends to be less sensitive to broader economic and financial market conditions and therefore can be a useful diversifier for portfolios.

In fact some positions, through, the use of derivatives may benefit from market volatility and therefore perform strongly while conventional asset classes are under stress. This has the effect of dampening overall portfolio volatility resulting in a smoother return profile for investors.

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