Private equity and real estate investments, often used as diversifiers against long equity assets, apply the same underlying strategies as those from which they are trying to diversify creating high volatility within the portfolio.
The report suggests that when hedge funds are added to the mix volatility is worsened as the hedge fund strategy is not considered; just being invested in a hedge fund is viewed as the source of diversification.
The report identified three asset classes: cash, equities and debt, and four strategy options. It suggests that in order to create a truly diversified portfolio, and to reduce volatility, a portfolio should include investments across each of the 12 options (four strategies for each of the three asset classes).
Over 30,000 portfolios were analysed, and found that systematic arbitrage strategies, for example statistical arbitrage were least correlated to other strategies in the cash and equities space, while directional discretionary approaches, such as long/short equities and distressed credit, should be used to diversify in the debt space.
Khaled Said, joint CIO and co-founding partner of Capital Generation Partners, said: “The key is to understand the strategies from the bottom up rather than grouping them by first-order characteristics such as asset class or vehicle type. Building this deeper understanding of investment strategies enables investors to build robust portfolios which consistently reduce risk.
“Many investment portfolios today are particularly overweight directional equity due to the inclusion of private equity and real assets. Our analysis shows that investors using an ‘enhanced’ benchmark portfolio should consider using cash arbitrage strategies as they are lowly correlated with these assets. ”
