Geopolitics, inflation, and Central Banks monetary policy have agitated financial markets in 2022, leaving returns and diversification in short supply. Over the last several decades, global equities and bonds have provided some level of diversification i.e. when equities have done poorly, bonds have often helped to compensate ” and vice versa.
But the last twenty years were a period of low inflation , few geopolitical frictions , free trade and thus far, 2022 has been a rare exception, with both equities and bonds suffering drawdowns.
Looking back prior to the financial markets history, the only calendar year we found with similarly steep declines in equities and bonds was 1974 (a year marked by an energy shock). While we dont know whether 2022 will end on a similar note, it seems clear that recent developments, from the end of central banks easy money policies to the beginning of a multiyear deglobalization trend, are likely to contribute to greater economic uncertainty and market volatility.
In this new world, what does regime change mean for the investors ? We believe alternative investments could play a vital role in improving portfolio resilience and returns and we want to focus on three topics we think alternatives allocators should consider:
rising market dispersion
equity-leadership transition from growth to value , and The need to break down silos in alternatives portfolios.
Higher market volatility often goes hand in hand with greater levels of market dispersion. But what types of strategies could potentially benefit from this environment? Long/short directional strategies may help enhance performance in a volatile market and their ability to modulate beta exposure may contribute to overall portfolio resilience. Macro strategies may also warrant a closer look in a period of greater dispersion, when the fundamentals of each asset may matter more. Macro strategies may offer diversifying characteristics and have the potential to benefit from higher levels of economic uncertainty and market volatility.
“Geopolitics, inflation, and Central Banks monetary policy have agitated financial markets in 2022, leaving returns and diversification in short supply”
After a long stretch of outperformance by growth stocks, value stocks have shown signs of life over the past year ” and deep value in particular. Despite the recent rally, the value factor has continued to trade at a steep discount to the market, especially outside the US. In addition to attractive relative valuations, higher interest rates and inflation may bode well for a continued rebound in value, which has tended to do well in periods of rising prices
Regardless of the specific timing and duration of a shift to value, we think the takeaway for allocators is that this may be a time to be thoughtful about factor exposures. Are there value-oriented strategies that might enhance an alternatives portfolio? Do certain managers in the portfolio have exposure to regions of the world that may be attractive from a value perspective (perhaps Europe or emerging markets, for example) or even just a value tilt in their philosophy and process that could be advantageous?
Finally we think a number of trends may provide rational for allocators to pull down artificial walls in their portfolios, including within their alternatives allocations.
For example, across the global economy we are witnessing what we have described as an innovation super-cycle, which was accelerated by the pandemic.
It has affected private companies as much as public companies, as evidenced by the shifting sector composition of the private equity market
We think this speaks to the need for allocators and managers to look across the entire equity ecosystem to understand sector dynamics and identify potential winners and losers, as public and private companies will increasingly compete with one another .
Taking this one step further, hybrid or crossover managers may be well positioned to identify arbitrage opportunities within the equity ecosystem.
Another area where allocators might do well to pull down walls is between traditional fixed income assets and diversifying alternative strategies that might help with the objectives typically associated with traditional fixed income. Given fairly muted return expectations for some areas of the fixed income market, for example, asset owners seeking higher returns and willing to take on some additional risk might want to consider potential fixed income strategies such as private credit and absolute return strategies (e.g., relative value).