As the saying goes, ‘there are decades where nothing happens, and there are weeks where decades happen.’ The sheer scale and magnitude of change for markets and economies over the last year led to significant capital destruction in bond markets. This level of drawdowns in Gilts has never been witnessed before, and has particularly impacted cautious investors. The combination of long duration (interest rate sensitivity) and low (and even negative) yields resulted in increasing risk for a typically lower-risk asset class. These dynamics meant ‘alternatives’ played an increasingly important role during 2022 when short-term correlations between traditional asset classes broke down. Equities and bonds fell in tandem, creating challenging conditions for multi-asset investing.
Diversifying the alternatives
A year ago, Parmenion’s Strategic Asset Allocation Committee broadened its alternative’s asset class from a single exposure of UK commercial property to multiple alternative sub asset classes: infrastructure, property, absolute return and short-dated credit. The idea was that property alone presented potential liquidity challenges. And with unappealing yield levels, the risks could be mitigated by reducing property exposure to 25% of the alternative’s bucket. By changing the mix, portfolios would gain exposures to additional streams of risk and return. So far, it’s proved beneficial to client outcomes.
The chart below shows the fund returns from each sub asset class within ‘Diversified Alternatives’, and the asset class present within our core solutions at Parmenion, since its reconstruction on 25th February 2022 to 24th February 2023.
Source: Morningstar Direct
You can see that while the asset class has registered a slightly negative return through this period (in the context of large drawdowns from fixed income, property and equity markets), it’s helpfully contributed to relative returns at the portfolio level. It’s no coincidence that the resulting effect of blending these funds together created a smoother return profile, and a lower standard deviation than most of the individual parts. Diversified Alternatives’ one year standard deviation was reported as around 5%, while the IA UK Direct Property sector was around 8%. Therefore, the new asset class managed to deliver better relative returns over this period with lower volatility – win-win!
The reason for acting a year ago was not just because of the well understood liquidity issues with property funds, but also because investing in alternatives in daily dealt form is now much easier. In other words, these days there are more types of alternatives we can practically invest in.
For example, the absolute return sector is far more established in investing. Here, the team selected the Janus Henderson Absolute Return fund, which seeks out opportunities both on the long and short side in the equity market. Therefore, the fund looks to add value regardless of the underlying market and economic conditions. Importantly, care needs to be taken when researching this sector. It’s essentially a mixed bag of vehicles utilising different instruments from a variety of asset classes, so it’s hard to make true peer group comparisons.
Watch this space
We’re always looking for new areas to strengthen risk adjusted returns within Diversified Alternatives, with flexibility to add in new and interesting non-traditional asset classes if they pass our robust investment criteria and rigorous due diligence process.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.
Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.