What role do alternatives currently play in investors’ portfolios?

Alternatives are being used to manage risk, particularly in regards to equities, and finding alternative sources of income in the absence of positive real returns

The panel has a diverse set of alternatives exposure, and preferences vary, ranging from real assets to hedge funds. Overall, while the most important factors appear to be meeting clients’ portfolio objectives and overall transparency of approach, there were calls for clearer definitions among alternatives categories.

The underlying impetus towards alternatives comes from finding ways to manage volatility, particularly in regards to equities, and finding alternative sources of income in the absence of positive real returns in most of the government bond markets, panel members concur.

This dual dynamic is summed up by William Dinning, chief investment officer at Waverton Investment Management. The firm splits the universe into two. On one side, the absolute return allocation attempts to mitigate volatility in an overall portfolio, and also looks to provide some return during periods of equity market volatility. ‘Among absolute return strategies, it has been difficult to find ones that do what they say they’ll do on the tin. But we think it’s still worth trying,’ he says.

The other allocation Dinning’s firm lumps together is real assets. He defines this as things other than equities or conventional property holdings that can provide some kind of return. ‘Some of that return might come from income, some of it might come from capital gain,’ he says. This allocation might not be fully uncorrelated to the economic cycle, he points out, but can perhaps provide access to different types of risk premium than might be available via conventional equities or corporate credit.

It is a view corroborated by Alex Orr, director within BlackRock’s alternatives specialists team, who says the firm is seeing distinct trends in both liquid and private markets, across all client segments. ‘When it comes to liquid alternatives and absolute return strategies in general, there has been much more of a focus on truly uncorrelated returns,’ he says. This comes from two aspects: one is the risk management perspective, which is manifest in tight net exposures and minimising market exposure, while the second comes down to the skill of proven portfolio managers who can generate returns from both sides of the book.

Shane Balkham, Chief Investment Officer at Beaufort Investment

Within the private market space, he says, there is a broad church of different investments ranging from private equity and private credit to real estate and infrastructure. ‘All of these classes bring different characteristics and different benefits. In the last few years, we’ve certainly seen an increase in real assets and private credit, as investors have been looking for enhanced yield,’ he says.

For Shane Balkham, chief investment officer at Beaufort Investment, alternatives are ‘something that gives a different outcome than equities, bonds or property might deliver.’ For his firm, this is achieved via a multi-strategy vehicle that uses derivatives to generate different exposures to different markets. Overall, he says, the golden rule is to be able to understand the underlying strategy: ‘We prefer things that are simpler. If it’s something we are not clear about, we won’t touch it,’ he says.

‘We prefer things that are simpler. If it’s something we are not clear about, we won’t touch it.’
Shane Balkham, chief investment officer at Beaufort Investment

Deconstructing alternatives

Tom Davies, senior investment manager at Quartet Investment Managers, picks up the point that the key is finding alternative sources of income.

At the same time, the ambiguity around different types of alternatives can lead to potential risks. Kelli Byrnes, consultant within BlackRock’s portfolio analysis and solutions team, points out the dangers of over-concentration, noting that in practice an alternatives bucket can sometimes consist of a single real asset fund.
‘An alts bucket can be a catchall for any type of thing that doesn’t fit neatly into traditional equity or fixed income categories,’ she notes. ‘It is vital to understand exactly what the role of that alternatives bucket is supposed to be,’ she emphasises.

Balkham suggests a helpful way of looking at the category is to consider the question in reverse. ‘I’d look at it backwards and say: “What are the managers trying to provide, and can I get that elsewhere in a more traditional manner? Can I deconstruct this alternative and bolt on an equity and a bond and property and come up with the same answer?”’ he says.

In general, he looks for things which can be outsourced to an alternatives manager. ‘Derivatives are an obvious example, but it is important to deconstruct and understand the drivers of the fund. Once you have clarity from that point of view, you have to consider whether the process is robust, sustainable and repeatable. Do the managers have a track record in this? Is it ultimately going to keep me awake at night, or is it something I know that’s going to add some diversification within the portfolios?’


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