Alternative Diversification Away From Equity-Bond Correlation

Stockholm (Ekonamik) – “The first quarter of 2019 has been the best quarter for hedge funds for many years, and most hedge funds are up about 5%,” says Andrew Draeneen (pictured), Head of Liquid Alternatives strategic capability at Schroders. “We have recovered much of the losses from the last quarter of 2018, when 80% of the hedge fund and liquid alternative industry was down.”

However, new concerns have emerged, according to the Head of Alternative Investments. “Now, investors are worried about valuations and credit spread levels being too tight. The Fed signalling in the US suggests that rates may have peaked at 2.5% and that the next move may be down rather than up. Slowing global growth may also imply tougher times ahead,” he notes.

“The liquid alternatives industry has been growing at approximately 25% per annum over the last ten years in terms of the number of funds and AUM,” Draeneen explains. “The market is maturing, and investors now have a great menu of different strategies they can use to build more robust portfolios.”

The main purpose of Schroders’ alternative strategies is to provide a broad range of diversification options to its clients. “We do not make calls on what the future holds,” the Head of Liquid Alternatives explains. “We recommend clients use all the tools in the toolkit and be as diversified as possible.”

“The one thing we are confident about is that there is much more correlation among equities and bonds then there has been over the last 10-20 years,” Draeneen notes. Echoing Ekonamik’s own recent foray into the drivers of equity-bond correlations, he notes that “if one is diversifying through a portfolio of equities and bonds, and markets are hit by a significant downdraft and turn bearish, the bonds may not act as the great diversifier that they have recently been. They may, but they may not,” the Head of Liquid Alternatives warns. “Clients should be seeking all sources of diversification rather than just traditional market betas. Our strategies fall into one of three outcomes that may resonate more or less with our clients, depending on the macro backdrop and their expectations,” explains the Head of Liquid Alternatives.

“We have growth-oriented strategies, ultimately trying to give investors equity-like returns but with less volatility. They make sense as a core holding in investors’ long term savings’ plan and have done well in the last 10 years,” Draeneen explains. “These include directional long-short equity strategies, long-biased long-short equity and fixed income strategies with a 0.3 to 0.5 beta to the MSCI world or the SP500.”

“Schroders’ Alternative solutions also includes strategies that are designed to be uncorrelated with the markets,” elaborates the Head of Liquid Alternatives. “They perform based on inefficiencies in certain asset classes. Relative value strategies, catastrophe bonds, equity market neutral and merger arbitrage are the sort of idiosyncratic strategies that can do quite well in a recessionary environment because they are not taking a broad market view.”

“Finally, we also have a suite of strategies that are more beneficial in inflationary environments and that tend to be more linked to real assets such as commodities,” he explains. “These strategies are interesting to clients that think we are going to see a material pickup in inflation. I think the consensus is that we are probably not, but it really depends on one’s view of the future.”

According to Draeneen structural constraints drive the demand in the liquid alternatives market. “Intermediaries, such as wealth management firms, asset managers and financial advisors are the main buyers of liquid alternative strategies. These clients buy these UCITS and daily dealing products for various operational and regulatory reasons. Institutional investors have longer duration assets and do not need the liquidity of a daily dealing UCITS product and may prefer the traditional Cayman hedge funds.”

The market is not rigidly segmented. “Of the US$ 21 billion we have in liquid alternatives, approximately 35% comes from institutional investors. They tend to come from markets like Italy, Germany and France where there is an aversion to using Cayman structures or from clients that like a strategy that is only available in the UCITS structure.”

“There is a lot of client interest in these types of structures,” Draeneen notes enthusiastically. “Some of the biggest brands of the hedge fund world have now entered the market. Approximately 70% of Europe’s largest hedge fund managers now offer liquid alternatives, and just under 30% of the US’s largest managers offer alternative products as well. Around 100 of the 430 largest hedge fund managers in the world are now offering liquid alternatives,” he explains.

“I think it is a perfect time for investors to embrace liquid alternatives,” he concludes.

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