During the era of low interest rates, alternative investments have emerged as a way of achieving higher returns in portfolios. This trend continues despite higher rates, with investments in strategies that are diversifying, uncorrelated to other market factors, and which benefit from market volatility.
Spotlight on the alternatives backdrop
In the last five or six months, many investors have refocused on fixed income for its higher returns and greater simplicity, especially for individual clients. However, the lack of clarity in the current investment landscape has renewed interest in alternative strategies with little correlation to traditional assets. This interest has grown further due to the disruption of the traditional balance of a 60/40 or 50/50 portfolio by the current positive correlation between fixed income and equities. This is where alternative investments can find their place.
Whenever there is more uncertainty and more dispersion between good and bad companies – instead of everything moving in the same direction – alternative strategies, especially those providing diversification, generate better returns.
Current strategy focus within alternatives
The systematic macro strategy, all trading strategies, and relative value remain non-directional options that do not bet heavily on market direction but thrive in an environment with wider spreads and increased volatility. We are experiencing significant volatility in interest rates and uncertainty about future rate cuts. Systematic strategies can benefit by taking multiple bets in all asset classes and then quickly change their positioning if the market does not move as expected. Within relative value, long/short credit strategies, which can take advantage of increased dispersion between sectors and companies, convertible arbitrage, where the market sees strong new issuance and limited competition, and catastrophe bonds (cat bonds), which have performed well and whose yields are currently attractive, are all areas of focus and serve as a good alternatives to traditional fixed income. As always, a balanced approach should be considered and investments in those strategies should be in line with investors’ risk appetites.
Tech sector and alternatives
There has been a strong rise in everything related to artificial intelligence. Within that sector, the prices of all companies have soared, but not all are equally good. This April, there was a correction and a turning point in prices after their significant rise. While it may not be an environment comparable to that of 1999–2000, there is overvaluation, some euphoria, and market concentration. For instance, last year on the Nasdaq, half of the companies had negative results and half positive, yet the index saw a huge surge, led by a few individual names.
Role of hedge funds and alternatives
If uncertainty persists and the positive correlation between equities and fixed income remains, alternative investments can provide attractive returns and add value to a diversified portfolio by offering other sources of returns. Alternative strategies act as diversifiers with higher returns than fixed income and a bit more volatility. They can also replace equities for those who decide to stay on the sidelines due to concerns about a possible recession because they have a higher potential for returns. Slightly more volatile alternative strategies, but also with higher returns, can serve as alternatives to equities. Given the significant opportunity cost of not investing, alternative strategies offer a crucial diversifying tool for an uncertain future.
Fredrik Langenskiöld