A regime change in progress
The end of 2016 represented a period of transition for global markets and it seems that we are currently in a new paradigm, particularly in the U.S. This regime change is from a slow growth environment, dominated by low inflation and accommodative monetary policy, to one where we expect growth rates should be faster fuelled by fiscal easing, tighter monetary policy and a transition from deflationary to inflationary expectations. Outside the U.S., the ECB should begin tapering its quantitative easing (QE) program in a near future, and the Bank of Japan has already admitted the limits to QE by shifting to a yield curve targeting policy.
While the falling interest rate/rising bond prices have historically provided a ‘cushion’ for portfolios in the face of equity volatility, rising interest rate volatility is expected looking ahead. As a result, this ‘cushion’ or diversification effect may at best be less pronounced or potentially not be available in the months and years ahead. If this transpires, by default, volatility of portfolios would necessarily rise, exposing investors to higher levels of risk without compensating return prospect. Should bond yields continue to rise as they have done in recent months, the harmful impact of this new environment on portfolios may be more apparent.
In light of this development, most investors have already been exploring options to begin the process of transforming their traditional fixed income exposure in order to be better positioned to respond to this new regime change.
Liquid alternatives defined as ‘diversifiers’ definitely belong to the proposed options. Either by taking advantage of their investment flexibility or by simply capitalising on a relatively nichy market or sector, these ‘diversifiers’ have the potential to find uncorrelated return drivers in specific uncrowded markets. Targeting a moderate risk budget and exhibiting a reasonable liquidity profile, they act as risk reducers within a global portfolio by lowering volatility, drawdowns and correlation to traditional assets.
In this paper, we propose three liquid alternative investment solutions, which are particularly well suited to complement a traditional non-risky allocation under the current market conditions. They are:
- a Discretionary Global Macro solution
- an European Senior Secured Loans solution
- an Insurance-Linked Securities (ILS) solution
Their rationale and competitive edge are detailed hereunder.