Since the global financial crisis (GFC) of 2007-2008, the levels of economic intervention and support by authorities worldwide have been unprecedented, and the stimulus measures have driven bond yields lower and equity prices higher. Although these support measures have been welcomed, they do leave investors relying on a combination of traditional equities and bonds with a conundrum: where and how to allocate their funds. The challenge is greatest in the bond markets where, unlike equities that can grow their earnings over time, most interest payments are fixed.
To put this into perspective: since the start of the GFC, the 10-year government bond yields in the US, the UK and Germany have fallen from highs of 5.3%, 5.5% and 4.7% respectively to 0.67%, 0.19% and -0.49%. These moves have been driven by the responses to firstly the GFC and more recently the COVID-19 pandemic. It is very difficult to make a case for owning a bond yielding less than 1% over any meaningful length of time, let alone a bond with a negative yield where a loss is all but guaranteed.
In this challenging environment there is certainly a strong case to be made for investing in alternative assets or strategies. The list of alternative investments available is as long as it is broad – it covers areas as diverse as private equity, high-yield bonds, hybrid capital bonds, equity and bond derivatives, structured products, property, renewable energy, infrastructure, volatility and even cryptocurrencies.
Some investors may choose to follow single-asset-class strategies, but for others, an allocation to a multi-strategy option will be more suitable. As an alternative investment to bonds, any solution chosen should be managed with an absolute-return objective and should seek to reduce the downside risk for investors.
FLEXIBILITY TO ADAPT
One of the main attractions of a multi-strategy fund is the flexibility to adapt to changing market conditions. This flexibility is a function of not having a set asset allocation benchmark, and allows the fund manager the freedom to defend when needed and to attack when opportunities present themselves.
For example, during the COVID-19 sell-off earlier this year, the Sanlam Multi-Strategy Fund reduced its equity exposure from 30% at the high to -10% at the low through active position management and the impact of equity index put options. This defensive stance allowed the fund to take advantage of prevailing market weakness by buying high-yield bonds and equity call options. The defensive action helped limit the drawdown at the peak of the sell-off, and set the stage for the attacking action that helped the fund to post a new all-time high as markets rallied back.
Unsurprisingly, selecting which fund to own is far from simple. The Morningstar database currently lists 687 funds in its alternative multi-strategy sector. Over the past year the average fund has returned -0.56%, with the best-performing fund rising 75% and the worst falling 63%. The top-performing fund was focused on distressed investments, while the worst was focused on fixed-income derivatives. To complicate things further, both funds, according to their Bloomberg data, had assets of less than US$1 million, which would have made them uninvestable for most people.
IN A NUTSHELL
The low interest rate environment looks set to continue for the foreseeable future. The need for portfolio diversification remains unchanged and with bonds offering little or no return, an allocation to a flexible, multi-strategy, absolute-return fund that can dynamically shift its asset allocation and has the freedom to seek opportunities in multiple asset classes makes a lot of sense. However, outcomes are not guaranteed and there can be huge deviations in returns. As always when selecting a fund, understanding a manager’s style and investment process is key.
Note by Alwyn van der Merwe, Director of Investments at Sanlam Private Wealth
Since the material global equity recovery in late March, we’ve argued that the prospective upside for this asset class looks rather muted from this high starting point. Although we acknowledge the uncorrelated behaviour or lower risk associated with global government bonds and offshore cash, the extremely low to zero yields have become cumbersome for investors who need to beat inflation over time.
The strategy and process of the Sanlam Multi-Strategy Fund provide an absolute-return building block for balanced fund solutions to our clients. Against this background, we’re advocating an approach in which global cash holdings are restricted and exposure to this strategy is increased – which is likely to beat inflation without incurring asymmetrical risk in the portfolios.
Mike Pinggera is the manager of the Sanlam Multi-Strategy Fund, a diversified, absolute-return investment fund incorporated in Ireland. The fund aims to participate in rising markets and defend capital during downturns.
