Somewhere between traditional fixed income and alternatives, long-short fixed income products have helped reduce volatility
2022 may be understated as one of the most traumatic years for investors in recent memory. For all the wreckage of the great financial crisis, the COVID-19 pandemic, even the tech crash, there were ports in the storm. Investors could move to traditional safe havens and rely — to some degree — on the non-correlated performance of fixed income and equities. In 2022 there was no safe haven, at least in traditional public securities.
Private assets, perhaps, offered some of the answer. While certain of these categories also struggled in 2022, and may have underperformed in the subsequent recovery, they offered a degree of ballast and non-correlation. However, their liquidity constraints have given many retail investors pause.
Imran Dhanani, head of retail distribution at RPIA, has seen a shift in the retail market towards a different kind of fund. He claims that long-short credit strategies can offer comparable non-correlated returns while maintaining a degree of liquidity, functioning as a mid-way between public and private assets.
“They’re a set of products that are liquid, can be offered daily, and can play a role as a diversifier,” Dhanani says. “They’re going to be more correlated to your equity in certain markets. But that doesn't mean they can't be a good diversifier, especially in rising or stable interest rate environments. I’m now seeing this shift into liquid alts, particularly long-short credit funds which exhibit a lower chance of permanent loss of capital than many private assets.”
Part of that shift, Dhanani says, has to do with perception. Many financial advisors have marketed themselves on allocating to private assets and alternatives to mirror how pension funds and institutions invest. The issue is that retail investors don’t have the assets, time horizons, or liquidity requirements of a pension or an institution.
There’s also a move away from balanced funds, in part because of the losses these strategies experienced in 2022, and in part because of the apparent lack of sophistication in using a one-stop-shop strategy. Dhanani sees a move among advisors to show more line items, which can also more effectively display how different parts of the portfolio are performing — rather than a single line showing positive or negative performance. In this new more nuanced picture advisors are drawing for their clients, Dhanani sees ‘liquid alternative funds playing a key role.
These mutual funds allow retail investors to go long, short, or use leverage. In the case of corporate bonds, these strategic overlays allow investors to control for interest rate risk and credit spreads. Investors can more tactically decide where, when, and how they want to take exposure to a corporate bond. This strategy proved its value in 2022.
When bonds and equities moved with positive correlation, few deviated from their fixed income strategies, paying lip service to their time horizons and long held adages about portfolio construction. These funds, however, were able to short government bonds and long corporate bonds to hedge out much of the interest rate risk in a fixed income portfolio. The result was very stable performance in a year when stability was hard to come by.
Dhanani explains that the stability these products offered in 2022 helped the retail advisor community see a value where before they only saw the higher risk rating on these strategies. The result has been a shift in the retail market in favour of these liquid alts, taking slices from the private asset, fixed income, and equity portions of retail portfolios.
“These products existed, but nobody was using them, and they performed so exceptionally well and provided so much diversification that they changed the narrative around now whether or not they belong long-term in a portfolio,” Dhanani says. “Where previously, everyone used equities, fixed income, and privates, now what you're getting is equity, fixed income, privates, and something in-between.
“We are starting to see advisors say private asset providers (especially from the US) are increasing in Canada, but they are also looking to find another way to diversify their income and return streams that aligns with their clients liquidity needs. And that's where we're seeing a lot of pick-up in liquid alternatives, and that's where we're fitting inside of books.”
