Volatile markets and an uncertain economic outlook have
underscored the importance of global diversification in recent months. Concerns
on the prospects for fixed income are widespread in light of a maturing 30-year
bull bond market and the inevitability of rising rates.
Meanwhile, the considerable highs that developed equity
markets have reached of late means that this asset class enjoys less obvious
valuation support than it did 18 months ago.
Reports of various professional investors increasingly
'going to cash' to safeguard assets is a reflection of lower conviction and
potentially reduced future opportunities in traditional asset classes.
Against this backdrop, given the unrelenting need for
non-correlated, diversifying returns, many multi-asset investors are considering
how they can reasonably enhance the alternatives exposure of their
Simply put, alternative investments such as hedge funds tend
to have a risk, return, liquidity and correlation profile that differs from
traditional asset classes, making them a valuable diversifier to a balanced
portfolio. The potential for generating absolute returns is clearly an
attractive opportunity for investors too.
If we look closer at hedge funds, they tend to explicitly
pursue absolute returns, so generally provide low correlation to traditional
investments and offer attractive risk-adjusted returns.
That said, investing in hedge funds themselves has been
beyond the reach or inclination of many investors. Issues have included lack of
transparency surrounding these investment vehicles and their process, lack of
liquidity and high costs.
The challenge, therefore, is to think about alternative ways
you can capture the returns associated with hedge funds. Specifically,
investors might consider whether the return streams that hedge funds generate
really need to be packaged in vehicles that present such challenges.
A growing understanding of the fundamental drivers of hedge
fund returns has allowed asset managers to develop strategies that offer
exposure to the diversifying components of hedge fund returns, in more
appealing vehicles, at a more competitive cost and with greater
A significant amount of 'alpha' from hedge funds can
actually be attributed to 'hedge fund beta'. Much like the progression of
alpha/beta separation in traditional equities and fixed income with the rise of
passive investing, accessing so-called 'alternative beta' involves isolating
the systematic, non-manager driven component of returns available from common
alternative investment strategies from the alpha generated by individual
Conceptually, there is no difference between traditional
beta and alternative beta, in that they both result from systematic exposures
to some risk factor.
In practice, a key difference is that to capture alternative
beta, there is a requirement for shorting, which makes it less straightforward
than capturing beta in the traditional investment space.
Nonetheless, alternative beta can be captured using
relatively simple, rules-based investment strategies with vanilla underlying
instruments in UCITS-regulated, daily tradeable vehicles. As investors
increasingly recognise the potential benefits of this transparency and
accessibility, the concept is becoming more mainstream in the industry.
Indeed, many of the underlying strategies used to capture
the various alternative betas would be familiar to long-only investors. Some
• Momentum investing: this exploits the fact securities that
have performed well tend to continue to perform well, whereas those that are
going down tend to continue to fall.
• Value investing: this takes advantage of the fact that
cheap stocks tend to outperform expensive stocks over time.
• Carry investing: this exploits the fact that higher
yielding assets tend to outperform lower yielding assets.
Significantly, however, the long/short nature of the
alternative beta strategies allows the exposure to the underlying asset classes
to be eliminated, which makes them truly diversifying to a portfolio of
In an environment where the investment case for traditional
asset classes such as equities and bonds appears increasingly cloudy, exposure
to non-correlated sources of return will become ever more important.
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