Investors need to remain diversified in the current climate and buy assets with low correlation to one another, according to Premier Asset Management’s Neil Birrell.
One way they can achieve this is by buying multiple asset classes and in particular alternatives, the chief investment officer said.
The manager of the five FE Crown-rated Premier Diversified fund said he prefers equities to bonds in the current climate but sees that the asset classes have become more correlated in recent years.
Indeed, over the last decade both the Bloomberg Barclays Global Aggregate and MSCI All Countries World indices are up by more than 120 per cent as the below chart shows.
Performance of indices over 10yrs
Source: FE Analytics
“I can see arguments for holding traditional bonds,” he said. “I think if you were to look around at the valuation of different asset classes, whilst the yield you are getting [for bonds] doesn’t look outstandingly attractive, I think interest rates might never go up again and in that instance there aren’t too many pressures around to burst this 37-year bull run in bonds.”
However, with the correlation of the two asset classes increasing, they no longer offer as much diversification benefit and therefore the manager has a zero per cent weighting to traditional bonds.
The fund has a 64.6 per cent weighting to equities and 20.3 per cent invested in alternatives with 6.7 per cent in property and 7.6 per cent in non-traditional bonds such as emerging market debt.
“Diversification comes by definition by owning different things and we believe it only really comes from owning different asset classes,” said Birrell.
“Equity managers will talk about their highly diversified portfolio but they are only invested in equities and they tend to move in the same direction.”
The manager added that despite negative sentiment to markets – with many analysts having decried ‘the most hated bull market in recent history’ – there are still attractive areas for investors.
One such area is alternatives, where the fund uses a mixture of some hedge funds, private equity assets, credit-orientated funds and property which in this instance is in listed equities.
“Alternatives are in there, one, because we find a lot of attractive individual investments in that area, but [also], two, to serve a very distinct purpose for this fund itself as we are aiming to achieve equity-like returns with lower levels of volatility,” he said.
The fund aims to achieve these returns with less than 70 per cent of equity volatility, which is seen as the priority of the fund.
“We have been around the 64 per cent [volatility] mark over the last three years or so and a lot of that comes down to the alternatives,” the manager added.
Indeed, over three years, the fund has returned 38.73 per cent, putting it in the top quartile of the IA Mixed Investment 40-85% Shares sector, though this is 12.92 percentage points behind the FTSE All World index.
However, the Premier fund has achieved this with volatility of 7.03 per cent, while the index has experienced volatility of 9.84 per cent.
As the below, the annualised volatility of the fund has remained below that of the index in each month over the last three years.
Rolling volatility of fund vs index over 3yrs
Source: FE Analytics
“Alternatives play a big part in dampening the volatility of the portfolio and they do this mostly through the lack of correlation with traditional assets classes – bonds and equities,” Birrell said.
“It doesn’t make us go out and buy something but it will influence the decision process that we make.”
Alternatives make up around 21 per cent of the fund in total and that is typically where it has been over the past three years, he added.
One example of the fund’s use of alternatives are the Bevan Howard Global and Macro funds, which together make up the largest allocation in the bucket.
“They do similar types of things and are run by the same manager but they are different strategies and they haven’t been the best of investments to be frank with you,” Birrell said.
Indeed, as the below shows, the funds have returned 12.49 and 0.23 per cent respectively over the last three years, significantly below their IT Hedge Funds sector.
Performance of funds over 3yrs
Source: FE Analytics
“There has been some issues with the returns that macro hedge funds have been making in general and Brevan Howard have had their own particular problems,” the manager said.
“However, in this portfolio we don’t mind that too much because whilst they haven’t given great returns as equity markets have been running hard and volatility has been very low, the way these funds will work – or at least the plan – is that when volatility spikes that is when they come into their own.
“They are playing different areas of the market that we are not going to access and they will typically be low volatility.
“So that is an attractive play for us and whilst they have not contributed hugely in terms of returns what we really care about is that when equity markets are falling that these investments kick in which they tend to do.
“When we have falling equity markets we will hopefully be picking up as small a portion of that fall as we possibly can,” the manager added.