A move away from bonds and into alternatives has been a key investment decision for Seven Investment Management’s Peter Sleep this year. 
Bonds have been on an incredibly strong run over the last decade, but many managers are now concerned that the era of extremely loose momentary policy and quantitative easing looks to be coming to an end.
Indeed, Quentin Fitzsimmons, manager of the T. Rowe Price Dynamic Global Bond fund, recently said: “A synchronised tightening move among major central banks could give developed market government bonds a volatile ride over the course of 2018.”
As such, 7IM senior investment manager Sleep has now moved some of his bond allocation to alternatives, taking a new 10 per cent weighting (in the firm’s balanced model portfolio) in the asset class earlier this year, split equally between five funds.
“We hope to make three or four per cent a year from our bonds through time but we don’t think we are going to make that over the next 12 months given where yields are,” he said.
“So what we have got here in our alternatives is hedge fund-like strategies that try and make 3 or 4 per cent a year regardless of the direction of the market.”
However, traditional hedge funds are expensive, with many using a 2 and 20 fee structure (a flat 2 per cent with a further 20 per cent on outperformance).
This, he argued, is too expensive for investors so he instead has created a portfolio of passive and rules-based funds.
“What we have got here is rules-based or quant funds; hedge fund-like strategies that try and make 3 or 4 per cent a year regardless,” he said.
“There will be periods where they lose money and periods where they make money but they will not necessarily be losing money when the market falls.”
First up is the £659m F&C Global Equity Market Neutral fund, run by FE Alpha Manager Erik Rubingh and deputy Chris Childs.
Launched in 2015, the portfolio is net long consumer staple, healthcare and utilities stocks, while short energy and technology companies.
Since launch, the fund has returned 23.96 per cent with volatility of 9.49 per cent and a maximum monthly drawdown of 11.07 per cent.
Performance of fund vs sector since launch
Source: FE Analytics
The fund, which targets 10 per cent volatility per annum, sits in the IA Targeted Absolute Return sectors and its main aim is to make a positive return over any three-year rolling period.
The equities are managed using a systematic stock selection process, fitting in with Sleep’s rules-based approach.
F&C Global Equity Market Neutral has an ongoing charges figure (OCF) of 0.79 per cent.
Next is the Neuberger Berman Multi Asset Risk Premia fund – another long/short portfolio of risk premia focusing on four styles (value, momentum, carry and liquidity) through four asset classes (equities, fixed income, currencies and commodities).
Risk premium is the return an investor can expect to make in excess of the risk-free rate of return (typically cash).
Alternative Risk Premia are systematic, long/short strategies designed to capture returns by taking well-known risks, be they compensation for uncertainty or event risk, investor over- or under-reaction or structural reasons such as investors’ impediments to shorting or employing leverage.
As such, the fund will take net long positions in the asset classes that it deems has an attractive risk premia while shorting those that do not.
Neuberger Berman Multi Asset Risk Premia aims to achieve a volatility of 5 per cent given the diversification benefits of its strategy while achieving an absolute return that has low to negative correlation to traditional asset classes.
Again, the portfolio is run using a systematic process, fitting with Sleep’s passive and rules-based philosophy. Since its launch in January 2017 the fund has lost 1.3 per cent.
Third is the $596m AQR Managed Futures fund, another long/short portfolio that uses a trend-following strategy.
The portfolio’s positioning is based on a multi-dimensional investment process that exploits short to intermediate-term price trends in global markets.
It mitigates risk by identifying trends that have become "over-extended" and may be due for a reversal.
The fund is 58.2 per cent net long equities and is not taking any shorts in equities. In fixed income it is 35.2 per cent net long though has a large short position to US debt and large net long positions in Europe and Asian bonds.
It is also 9.4 per cent net long currencies – though within this there is a significant short position on the dollar while a large long position on the euro.
Performance of fund vs sector since launch
Source: FE Analytics
Since its launch in 2015 the fund has returned 7.95 per cent with annualised volatility of 17.11 per cent and a maximum drawdown of 11.51 per cent. The fund has an OCF of 1.05 per cent.
Next up is the four FE Crown-rated VT iFunds Absolute Return Orange fund, which aims to beat cash returns over a rolling three-year period with an expected annualised volatility of 9 per cent per year.
Currently, the fund holds the majority of its assets in overseas equities, particularly those of the developing world as the volatility of these, traditionally riskier, assets remains relatively low and their risk adjusted performance ranks them higher than the majority of assets from the developed world.
“If, however, volatility increases then the fund will automatically reduce its exposure should this be required to maintain overall risk levels,” the managers said in the fund’s latest factsheet.
Over the last five years VT iFunds Absolute Return Orange, which has an OCF of 0.91, has returned 60.73 per cent with volatility of 7.99 per cent and a maximum monthly drawdown of 8.23 per cent.
Finally, the $144m NN Multi-Asset Factor Opportunities is also in the 7IM alternatives bucket having been launched in May 2017.
The long/short portfolio uses factor-based investing through momentum, value, carry flow and volatility themes. Momentum intends to benefit from the tendency of performance to persist while value looks for perceived incorrect market valuations.
Flow investing is when markets are subject to predictable and excessive buying and selling pressures in the short term. The fund will either go long excessive supply and short excessive demand.
Carry intends to benefit from the tendency that instruments with higher yields outperform those with lower yields while volatility looks at the tendency that implied volatility is generally higher than realized volatility.
The strategy aims to avoid structural long/short biases and strives for low correlation with traditional asset classes thereby offering diversification benefits.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
NN Multi-Asset Factor Opportunities, which aims to beat the 1 month US Libor rate over five years, has returned 0.82 per cent since its launch in May this year. The fund has an OCF of 0.83 per cent.