As we enter the later stages of the economic cycle, coupled with ever dominant geopolitical headlines, volatility is here to stay and can be overwhelming for investors. Correlations between bonds and equities have been elevated, while 2018 was a good reminder of how risk assets can exhibit volatility and that asset allocation does not pertain to risk allocation. With rates on the rise and equities looking expensive, low-risk investments actually now have a real yield, despite the temptation to allocate to cash.
Cash cushions, however, are not always that comfortable. Following a challenging Q4, for the year to 25 February, the S&P has returned 11.8% and the FTSE 100 9.4%, so derisking and waiting for a better entry point may have been costly. Average cash allocations levels are at 9% for industry medium risk portfolios.
Investors could, through a blend of direct, active and passive short-maturity bond allocations, enhance yield while maintaining liquidity and quality as part of the cash allocation.
There is also a growing interest in the alternatives space, which offers a combination of return enhancement, yield pickup, risk reduction, and inflation protection. Asset allocators are considering gold as a diversifier following more dovish tones from the US Federal Reserve, which has seen the yellow metal rally 13% from its lows in August 2018. Global assets specifically in the hedge fund industry have more than doubled from $1.4trn in 2008 to $3.2trn in 2017, albeit with mixed returns; the HFRI Equity index lost 1.2% in 2018 versus the MSCI World, which lost 3.3%.
Alternatives provide little-to-no correlation to traditional asset classes over the longer term but investors should remain selective. With the growth of Newcits (alternative Ucits) products, choice is available within a regulated structure. However, we still observe 40% of the alternatives sleeve allocated solely to long/short equities and debt strategies. Clients can adopt a dynamic approach to alternative asset allocation to enhance risk adjusted returns.
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