Time for a more alternative approach: looking beyond the 60/40 portfolio

7 Feb 2020

Tom Kehoe CAIA, global head of research and communications at the Alternative Investment Management Association

Investors recognise that they have done very well investing in equities over the past decade. As we enter a new decade however, there are reasons to believe that the current financial cycle may be coming to an end.

Interest rates are rising, as quantitative easing gives way to quantitative tightening. Geopolitical tensions continue to increase, amidst a return to troubles in the Middle East, as well as an ongoing US/China trade war. Closer to home, the full extent of the UK’s decision to leave the European Union, including its impact on financial markets, is still very much unknown.

In its most recent forecast for this year, Morgan Stanley estimates that a classic investor portfolio made up of 60% equities (either European or US) and 40% bonds will return just over 4% per year over the next decade, halving the returns made over the past 10 years.

Given this less than rosy outlook, diversifying investment strategies is more important than ever before for pension scheme trustees faced with managing investment portfolio risk, whilst identifying solutions that will generate enough portfolio returns to support future liabilities.

When markets become more volatile and beta returns deteriorate, investors will need to look beyond asset managers who provide investment returns that simply beat an equity benchmark. Those who believe that markets will exhibit increasing uncertainty and dispersion should consider making an allocation to the unconstrained strategies delivered by hedge funds.

Investors continue to view the key attraction of allocating to hedge fund strategies as their ability to provide better diversification and improved risk-adjusted returns for their overall portfolio, through utilising different risk and return drivers. An allocation can provide pension funds with more flexibility to protect and grow the capital of their beneficiaries. By integrating hedge funds into the wider investment portfolio, this should provide investors with returns that are uncorrelated with returns derived from investing in equites and bond markets.

Here are just a few examples of investment strategies that could positively impact on a pension scheme investment portfolio:

  • Long/short equity hedge funds can theoretically limit the losses suffered by their investors during a downturn of equity prices.
  • Infrastructure funds can offer investors access to investments with timespans that outlast equity and bond cycles.
  • Finally, many private credit hedge fund managers offer their investors exposure to a different part of the corporate world, access to the illiquidity premium (excess returns gained by investing capital for the long term), while providing essential funding to a crucial pillar of the global economy.

If you would like to understand more about the benefits of allocating to hedge funds, AIMA teamed up with the CAIA association in producing a series of primers on the hedge fund industry.

To learn more about these as well as access our investor-led research on alternatives please go to our website.

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