By Lee Matthews, managing director and head of UK retail sales at Man Group
Since the outbreak of war in the Middle East, diversification across traditional asset classes has been in short supply.
Equities and bonds have again become positively correlated as inflation has climbed. Gold has not behaved as the portfolio hedge many investors expected.
At the same time, the US equity market remains expensive. Valuations by some measures, such as the cyclically adjusted price-to-earnings (CAPE) ratio, are nearing dotcom-era levels.
Crowded AI-related names have, of course, helped drive valuations – and market concentration – higher. But with semiconductor stocks now dominating emerging market indices too, many wealth managers find themselves exposed to global equity funds heavily weighted to richly valued stocks driven by a dominant theme.
This reshaping of markets leaves allocators in a bind – just as interest rates appear set to remain higher amid elevated inflation and ongoing geopolitical risk. As a diversifier, traditional fixed income is unlikely to offset losses should equity markets enter a period of stress.
As a result, it has become increasingly important for investors to identify sources of return that are genuinely driven by different risk premia rather than simply packaged in different ways.
Here, liquid alternatives can play an important role in portfolio construction.
Often overlooked during prolonged equity market rallies, the appeal of liquid alternatives has never been that they consistently outperform traditional markets.
Rather, they seek to generate returns through different drivers, making them potentially valuable when traditional asset classes become more closely correlated. Periods of high volatility, sharp market rotations or changes in the macroeconomic environment are often when the diversification benefits of these strategies may become more apparent, helping to reduce overall portfolio volatility.
The range of liquid alternative strategies available to wealth managers has expanded considerably in recent years. While some of the largest multi-strategy hedge funds remain difficult to access through vehicles suitable for most private client portfolios, the UCITS universe now offers exposure to a much broader range of institutional-type investment strategies than was available even a few years ago.
These strategies include discretionary and systematic approaches, including long/short equity, global macro, managed futures and multi-strategy portfolios. Used selectively, they allow wealth managers to diversify away not only from traditional equity and bond risk but also across different alternative return streams. In some cases, blended approaches provide access to complementary strategies that might otherwise be difficult to implement individually within a wealth management portfolio.
As ever, cost remains an important consideration. Like all investors, wealth managers have become accustomed to accessing market beta for a few basis points, so any allocation away from traditional index exposure inevitably faces greater scrutiny.
That, however, has encouraged the development of liquid alternative strategies with simpler fee structures, including systematic approaches with flat ongoing charges and no performance fees. For many firms, that is enabling straightforward conversations about what role alternatives can play in a portfolio, not just whether they can justify their charging structures.
That broader discussion reflects the continuing evolution of the wealth management market. Portfolios are increasingly being built around clearly defined investment objectives rather than individual products or asset classes, creating demand for more curated solutions. As a result, there is more emphasis on combining complementary strategies that address specific portfolio risks, often within a specific fee budget.
Partly, this reflects the increasingly sophisticated portfolio construction and risk management approaches being employed by wealth managers. Specialist managers will continue to play an important role in portfolios, particularly where they offer deep expertise in a particular asset class or investment strategy.
However, demand is growing for managers capable of combining different risk drivers within a single framework, helping portfolios avoid reliance on any single source of return.
There is no doubt that the investment environment today is complex: it is not defined purely by high valuations or geopolitical risk or shifting economic regimes. But it is against that backdrop that many portfolios have become more dependent on a relatively narrow group of companies within a similar space. Mitigating the risks this poses is becoming an increasingly important part of portfolio construction.
Wealth managers cannot predict how markets will move from here. But they may improve the resilience of portfolios by ensuring they contain genuinely different sources of return, providing a potentially valuable offset when traditional diversifiers fail.
