For investors looking for uncorrelated returns, liquid alternatives can present alpha-generating opportunities.
It is an unappreciated fact that many of the most conservative investors are invested in some of the riskiest assets, thinks Davide Cataldo, Head of Absolute Return Multi-Strategy with Pioneer Investments. Holders of 10-Year German Bunds lost about 8% from mid-April to mid-June this year alone. They could see more of their capital eroded should rates rise.
Developed market equities look at least fully valued, particularly in the US, leaving single asset class, balanced, and long-only multi-asset investors facing tough decisions. There are few unexplored areas of the market. Investors need to expand their investment universe and invest beyond traditional asset classes.
“Long-only fixed income managers can lower their duration, but not go negative,” says Cataldo. “The ability to go short equities or invest in relative value strategies is an added advantage if you think valuations are full, and you still want to generate alpha.”
Liquid alternatives aim to provide diversification, reduce directionality and act as shock absorbers at times of market stress. They seek to capture alternative sources of return while remaining relatively uncorrelated with equity and bond markets. To pursue these features, it is key to build a process that seeks to generate multiple, low correlated sources of return by investing in traditional and non-traditional asset classes.
“We believe a well-designed investment process should seek effective diversification through allocating risk across four components. The Multi-Strategy team refers to these as the four key pillars,” says Cataldo.
The process starts with the Macro Strategy, the directional top-down element that expresses the view of the world. The Macro component may also include long-term structural thematic investments, such as Robotics and Longevity.
The second pillar is Macro Hedging, where independent specialists assess risks to the Macro Strategy and seek to protect portfolios from “tail risks”.
The third pillar, Satellite Strategies, tend to be relative value in nature and invest across multiple asset classes. Relative value investing can dramatically expand the investment universe and help generate new sources of alpha, independent of the equity and bond market. This is a key differentiator from long-only funds that are directional in nature. Each Satellite Strategy has a target price and strict drawdown management levels to ensure disciplined position management.
Finally, Selection Strategies aims to improve diversification and generate income by investing in sovereigns and high quality credit while seeking to generate stable yields above cash rates. The team sticks to the upper levels of high yield in an effort to protect capital from unexpected losses.
The process has been steadily refined. “We believe an approach that pursues new sources of returns, downside mitigation and volatility management becomes fundamental in building a robust portfolio,” says Cataldo. “We’ve seen turmoil across several asset classes this year, including bonds, emerging markets and commodities. For investors looking for uncorrelated returns, liquid alternatives can present alpha-generating opportunities in such an environment.”
Cataldo suggests liquid alternative solutions could play an important role in insulating investors during a period of expected monetary policy tightening, and could act as a complement to existing allocation.
Davide Cataldo, Head of Absolute Return Multi-Strategy at Pioneer Investments
Disclaimer: Unless otherwise stated all information and views expressed are those of Pioneer Investments as at 1 October 2015. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies.
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