Keeping an eye on downside risks with liquid alternatives

Robert Steiner, Sales Director, Franklin Templeton Switzerland

The current situation in the stock and bond markets is unsettling many investors and new approaches are being sought. Robert Steiner of Franklin Templeton Switzerland sees good reasons for investing in Liquid Alternatives resp. Multi-strategy and multi-manager approaches are talking.

Financial markets are challenging right now: the massive expansion of central bank balance sheets in developed countries since 2008 ends. The enormous liquidity glut that has caused prices to rise around the globe is gradually ebbing away. "We see increased volatility, sharp corrections and rising inflation. In addition, macroeconomic uncertainties threaten the stability of the markets", says Robert Steiner, Sales Director, Franklin Templeton Switzerland.

He thinks going forward, the biggest challenge may be that traditional diversification via bonds and equities may not prove successful in this new market phase especially as markets begin to feel the pressure of rising interest rates.

Steiner sees good reasons for Liquid Alternatives in this market situation. This term describes hedge funds that can be traded on a daily basis, i.e. liquid, and that retail investors can also buy. Specifically, those liquid alternatives with a multi-strategy and multi-manager approach may prove valuable to equity and bond portfolios due to their diversification effects. A multi-strategy, multi-manager portfolio consists of several standalone hedge fund strategies (multi-strategy component) whose day-to-day operations are managed by external hedge fund managers. Each of these hedge fund managers specializes in a particular hedge fund strategy that performs different tasks in different market situations.

Risk and return characteristics of hedge fund strategies
Hedge fund strategies have historically delivered good long-term returns compared to traditional asset classes (See Fig. 1). Their good performance during this period was mainly due to the fact that they fared much better than traditional assets during the bursting of the new-economy bubble in 2001-2002 and the financial crisis of 2008-2009, Steiner explains. At the same time, hedge fund strategies have often been relatively stable during periods of strong equity markets, he said. When risks are compared to returns, the risk from all of the hedge fund strategies is more in line with bonds, while their returns are comparable to stocks (See fig. 1).

Rising interest rates bring opportunities for long-short strategies
During the last 10 years, interest rates have been kept artificially low for the most part, according to Steiner. Here's how less economically well-off companies have been able to survive without problems thanks to relatively low financing costs. "But if interest rates gradually rise as z.B. In the U.S., we often see larger valuation differentials among companies in certain sectors", he says. The recent winners have been the highly liquid technology companies, which have been able to escape from sectors with higher debt ratios such as z.B. Have been able to significantly outperform in the utilities sector. The separation in the value development influenced by the effects of higher interest rates thus creates an alpha opportunity.

Lower downside risk under extreme market conditions
The extent to which hedge fund strategies help reduce downside risk can be demonstrated by the most extreme periods of negative equity market conditions in the past 20 years, Steiner says. Hedge fund strategies would have held up comparatively well in the five one-month periods when global equities suffered the biggest losses. Example September 2002: stocks lost 11 percent, hedge funds only 2 percent; October 2008: stocks lost 19 percent, hedge funds only 7 percent. Or in 2018, the most difficult year for stocks on record: in February, stocks lost more than 4 percent, while hedge funds lost 1.8 percent. In October, equities fell 7.3 percent while hedge funds lost less than half that too.

"The current situation on the stock and bond markets poses challenges for investors. Macroeconomic risks such as those related to geopolitical hot spots, the opposing monetary policies of major central banks, rising interest rates and inflation can threaten market stability. Hedge fund strategies offer investors valuable opportunities to diversify their portfolios" Draws Steiner Conclusion.

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