AMP Capital has exposure to a diversified mix of alternative investment strategies (“alternatives”). This guide seeks to provide a broad overview of the different types of alternatives, from defining what they are to understanding their role in multi-asset diversified portfolios. We also highlight some of the alternative managers we invest with and the process by which we select managers in this space.
Investing in Alternatives
Investing in alternatives offers both compelling portfolio advantages as well as significant challenges. We believe that alternatives can deliver attractive risk-adjusted returns on a stand-alone basis while also bringing diversification benefits to an overall multi-asset portfolio. Alternative strategies access a broader investment universe outside of traditional asset classes, such as equities and bonds.
However, along with the benefits, there are also challenges to investing in alternatives. Some of these challenges include higher fees relative to traditional investments, less liquidity, and resourcing for the level of due diligence required. At AMP Capital, our Alternatives Team partners with some of the highest quality firms in the world to research and manage market leading strategies. We also have the added benefit of a strong governance framework to ensure that the highest standards in due diligence are met, while our scale helps us to gain the most favourable pricing possible.
The definition of alternative assets and strategies across the industry is very broad with the term meaning different things to almost all investors. Typically, alternative assets include anything that does not fall into the traditional fixed income listed equity buckets. For example, alternative assets may include infrastructure, property, agriculture, and private equity. Alternative assets can also be opportunistic investments that span across asset classes or investments which are expected to offer some diversification features to equities and fixed income. It may also be assets classes that are new.
Alternative strategies, on the other hand, may include hedge funds and their sub-strategies as well as absolute return strategies. We define absolute return strategies as long / short investments that aim to deliver consistent returns above cash which are not measured against a benchmark. The focus of this guide will be on a sub-component of alternative strategies, specifically hedge funds and absolute return strategies
Table 1: Alternative assets and alternative strategies
- Real estate
- Real assets
- Private equity
- Hedge funds
- Equity long-short
- Event driven
- Relative value
- Global macro
- Managed futures
- Absolute return
Role of Alternatives in Multi-asset portfolios
Alternative strategies are attractive investments as they are expected to deliver excess returns above a traditional investment benchmark (alpha) as well as provide diversification benefits multi-asset portfolios. When done well, we believe that alternative strategies can help multi-asset portfolios achieve their target returns with lower overall volatility and lower exposure to risk of extreme losses.
Investors typically invest in alternatives for the following reasons:
- As another source of returns that is not reliant on traditional asset classes (e.g. agriculture)
- To provide diversification away from market risk (beta) towards strategies which are more reliant on investment skill (alpha) (e.g.hedge funds)
- To reduce a portfolio’s overall volatility as these strategies tend to be less volatile than equities and have typically exhibited lower correlations to other growth assets (e.g. absolute return funds)
- To take advantage of market inefficiencies, illiquidity premiums, and opportunities that are not usually possible with traditional listed equity investments (e.g. private equity)
Table 2: Defining single and multi-strategy alternative strategies, their equity correlation and return drivers
In environments where the valuation case for traditional asset classes can be arguably stretched, alternative strategies provide a means for investors to re-allocate away from equity markets, credit and fixed income, but still target growth-like returns. The lower expected correlation these alternative strategies have with other asset classes also provide the added benefit of dampening any market drawdowns.
Table 3: Correlation of hedge funds versus traditional asset classes
Source: AMP Capital as at August 2015
One could argue that another way to reduce a portfolio’s risk levels is to sell equities in favour of a higher weighting to bonds or cash. While this is possible for more conservative portfolios, which have lower investment objectives, we believe that there are a few drawbacks to this approach. Firstly, investing in bonds can introduce interest rate risk and secondly, bonds offer probably the lowest returns of any asset class over a medium-term horizon. Moreover, de-risking portfolios into cash can only be a tactical move as doing so reduces a portfolio’s ability to meet its long-term return objectives. As such, diversifying a portfolio away from equities or other growth assets into alternative strategies helps to maintain the total portfolio’s long-term expected return, while reducing market risk (or beta) and potential drawdown during periods where returns are expected to be volatile.
To illustrate the potential for alternative strategies to reduce a portfolio’s overall volatility, Chart 1 compares the Dow Jones Credit Suisse Hedge Fund Index with the MSCI World Index during periods of market stress between 2000 and 2014. What we see is that while investors should not expect these strategies to produce a positive return in all market environments, they should expect to see alternative strategies helping mitigate the impact of drawdowns. For the 15 worst performing months for global equities between 2000 and 2014, hedge funds, as represented by the Dow Jones Credit Suisse Hedge Fund Index, sustained less severe losses and even generated positive returns in a few of those months.
Chart 1: Performance of hedge funds against global equities during market stress
Source: Blackrock as at December 2014. Past performance is not a reliable indication of future performance
Important note: The information in this document is provided only for the use of financial planners and is not intended for investors. The financial planner remains responsible for any advice/services they provide to clients including making their own inquiries and ensuring that the advice/services are appropriate and in accordance with all legal requirements. Therefore, planners must not attribute any advice/service to AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) (AMP Capital) or in any way suggest that AMP Capital is the author of any part of that advice/service. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital. While every care has been taken in the preparation of this article, AMP Capital makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Before making any investment decisions, individuals should consider the appropriateness of the information in this article, and seek professional advice, having regard to their own objectives, financial situation and needs. © Copyright 2015 AMP Capital Investors Limited. All rights reserved.