Investors should consider a greater exposure to alternative assets for diversification, according to Henderson’s James De Bunsen, who believes this is needed more than ever to weather looming market volatility.
The manager (pictured), who is part of Henderson’s multi-asset team headed by Bill McQuaker and Paul O’Connor, believes a dearth of opportunity exists in diversifying away from equity markets, with historically low yields on standard fixed income securities and a macro environment less likely to suit bond funds.
Therefore he has been increasingly looking to find less correlated securities in more niche parts of the market.
“It is not a straightforward part of the market to get access to but the key thing at the moment is diversification. We have got used to bonds going up when equity markets are crashing and mathematically that is not really feasible now. That is why we have to rely a bit more on alternatives for diversification,” he said.
“Diversification is one of the only free lunches in investing, which is why we run multi-asset funds – to really give you that broad exposure.”
“For example, if you take two stocks and blend them together in a portfolio you will get the weighted return of those two stocks but you don't get the weighted volatility unless they are completely and perfect correlated to each other. This minimises and reduces the risk.”
He says that holding assets with low correlation to core equity markets is particularly important at present and that investors should be careful that what is claimed to be an ‘alternative’ does exactly this.
“We don't just buy alternatives for the sake of it or because they have a low correlation with equities. If we think equities are going up then we will own them and we don't want to buy something that will go down. The point is that looking back over the past 20 years you have had a pretty attractive annualised return from all asset classes. So it is not just about reducing risk but improving returns,” he said.
“It is also really important to remember that correlations are not static and we have got used to a regime where bonds have been negatively correlated to equities. Over the past 15 years they have often been positively correlated with equities.”
“You can’t just put [alternatives] in your portfolio and close your eyes and expect them to perform in the same way as equities and fixed income. You have to look at valuations and what the sensitivities are to interest rates or inflation.”
De Bunsen joined the Henderson multi-asset team in December 2012. One of the best performing portfolios the team manages is the four-crown rated Henderson Multi Manager Diversified fund.
According to FE Analytics, it is a top-decile performing portfolio in the IA Mixed Investment 0%-35% Shares sector over three and five years but has had a shakier past year, underperforming the sector average.
It has returned 44.46 per cent over five years while the average fund in the sector gained 28.35 per cent.
Performance of fund and sector over 5yrs
Source: FE Analytics
Despite holding a whopping 20 per cent in cash, it also has about 12 per cent in alternatives and about 5 per cent in property. A further 18 per cent is made up ‘others’, which is likely to be a mixture of alternative-like investments.
“Property is pretty mainstream these days but we think it should still be considered as an alternative because it does act in its own unique way to fixed income and equities,” De Bunsen said.
However he says investors should also consider private equity, hedge funds and renewables for diversification.
“Alternatives are somewhere where you really need to do your research. There are some strategies that will never work and some that will fail. By hedge funds I mean the alternative UCITS funds – I am not talking about scary unregulated hedge funds. These are managers who thrive in volatile markets.”
“We really like the long-term story for infrastructure. You have economic infrastructure – which invest in airports, toll roads etc – and these may have some economic sensitivity so they are not completely safe from what is going on.”
“Then you have social infrastructure – schools, hospitals that sort of thing. There are number of investment trusts that invest in that sort of infrastructure. It is incredibly dull, stable revenues with long-term contracts that are backed by government.”
The manager favours the Pantheon International Partners IT for private equity, which invests into several different private equity funds globally.
“It is one of our main holdings. It is a global fund of private equity funds. Highly diversified. It is not for the faint hearted. We all know that emerging markets are volatile for both equities and bonds but if you go into private equity you will quickly realise that the rule of law and property rights are not what you're used to.”
It is up 101.9 per cent over the past decade, meaning it has beaten the average IT Private Equity trust over this period but not its benchmark – the FTSE Small Cap ex ITs index.
Performance of trust, sector and index over 10yrs
Source: FE Analytics
However, while it has had some huge falls it has mostly had a low correlation to smaller cap listed equities that make up the index.
“You also get really niche areas of the market such as litigation finance where you essentially finance court cases and if they win that court case you get some of the proceeds. Another area we like is renewables: wind farms, solar etc. The key thing is it is heavily subsidised by the government and the wind and sunshine has no correlation with equities.”