It is the belief of the Premier multi-asset team that central banks have over recent years caused traditional assets to be boosted by price inflation.
Their actions include low interest rates, resulting in negligible cash rates for savers and cheap access to credit for borrowers, and a willingness to support inflationary efforts for the avoidance of deflationary effects.
The impact of these actions is evident in most risk assets including equities, where the market has risen faster than corporate earnings, but also in government bond markets, which have been added to the ‘risk asset’ camp.
The cost of holding UK gilts as an insurance asset is quite hefty in an historical context, with the meagre yields available providing limited compensation for inflation risk. It seems inappropriate to rely on the historic asset correlation between bonds and equity, because it may not hold looking forward.
Hedge funds used to assist with this diversification, although their accessibility and failure to live up to expectations has seen interest in these investments fall. Other options are not easy.
First and foremost, genuine asset diversification generally comes with the complication of greater liquidity considerations, as alternative assets by their very nature are not typical or mainstream investments tradable on an exchange. Here, the flexibility and benefit of the London Stock Exchange has seen the development of listed structures that enable a pooled-capital vehicle to enjoy the benefits of a closed-end fund structure.
There have been plenty of closed-ended launches such as CatCo Reinsurance Opportunities, Burford Capital (litigation finance) and more latterly BioPharma Credit (life science lending) that we have used at one time or another. Another asset class that has gained wider recognition has been that of volatility. It is now possible to trade volatility via Vix, as a means of benefiting from higher levels of volatility, typically associated with market falls.
Liquid alternatives has been another growth area. These use traditional assets and liquid instruments (including options and futures) in a more flexible manner to deliver an alternative strategy to traditional long-only investing. These can be in the form of equity long/short funds that are either market neutral or absolute equity (retaining some beta flexibility). They can also use arbitrage strategies, such as mergers and convertibles.
The most easily accessible type of absolute return fund has been in the form of long/short equity. In essence, these try to largely remove the directional risk of markets and harness the managers’ stock-picking alpha in a purer way. This can certainly aid long-only equity diversification where beta can dominate the returns achieved. However, investors probably felt a sense of irony in seeing strong equity returns during 2016 while absolute equity funds largely struggled.
Selectively, we have been introducing alternative asset exposures for several years for the positive return and diversification contribution, and also as a portfolio stabiliser in the absence of traditional bonds, and have found ways to actively blend selections to seek low portfolio correlation. This has reduced volatility and drawdown while still producing a positive return.
Ian Rees is deputy head of multi-asset funds and head of research at Premier Asset Management
