'Liquid alts are a diversification tool not a hedge'

Investors who think liquid alts will be their saviour from market meltdowns are missing the point, according to a leading strategist.

Myles Zyblock, chief investment strategist at Dynamic Funds, told WP that anyone who thinks alternative assets will eliminate the impact of stocks and bonds on their portfolio is barking up the wrong tree. This is a common belief and it might create confusion among retail investors now the vehicle is accessible to them.

He believes that investors should incorporate them into their portfolio, although he stressed that liquid alts are not a hedge but a long-term diversification tool because of their low correlation to traditional stocks and bonds.

Slogans that hail alternative funds as the funds for now also reveal a lack of understanding, added Zyblock, who said the only timely thing about them in Canada is the fact they are now available to retail investors, who can buy them like they would a mutual fund.

He said that, for example, instead of an alt fund, if he wanted to hedge against equity market downturns, he’d opt for buying a put option on the S&P500 as protection on the downside. Alternatives, meanwhile, run independent of equities so are therefore a more effective long-term diversfication tool.

He said: “Ultimately, by introducing an uncorrelated asset into your traditional stock and bond portfolio, you are enhancing the ride over a long period of time either through an improvement in the return profile or a reduction in overall portfolio risk. This doesn’t mean that all of a sudden alts are going to be your saviour from the equity meltdown we saw [in December]; that’s not it at all.

“Over long periods of time, an uncorrelated asset is going to help the behaviour of your portfolio because it just doesn’t beat to the same drum. It doesn’t necessarily beat to an inverse drum either, it beats to a more independent drum.”

He added: “A mistaken idea for alts is that 'now is the time'. The only reason it’s now is because we’ve had a regulatory change that allows for easier access. You could have said 'now' 10 years ago, it’s just that they are accessible now.

“If you have 10-15-year goals for investing before retirement, alts will incrementally help the risk-adjusted returns for your entire portfolio through time. In my opinion, it’s not a saviour, you’re just expanding the types of tools in your diversification tool box."

Zyblock said that any investor or advisor unsure of the value of liquid alts should look to the institutional pension and endowment funds like Yale and Harvard that have constantly been adding to their exposure over the years to the extent that many have 25% of their portfolio allocated to alts.

These institutions dominate the asset class which, globally, boasts about $6.5 trillion in assets.

“That’s been rising over time,” said Zyblock, “so obviously institutional money managers who have been around for decades think these liquid alts have a beneficial impact on their portfolios and have increased them to quite some size.

“Looking at what they’ve done, a retail investor now has an easily accessible option to include these in their portfolios and I think they should.”

Dynamic recently added two new funds to its own alternative suite, the Dynamic Alpha Performance II Fund and the Dynamic Premium Yield Plus Fund, and have already begun the process of educating investors.

How to recognize a good fund from a bad one will, like with any other investment, be crucial. Zyblock expects a “marketing grab” over the coming months and told investors to be wary of what’s being offered.

He said: “If it’s alternative, it should have low correlation to traditional asset classes like bonds and stocks, and it should have a positive expected return over time. What that means to me is know the strategy you are getting involved with but more importantly, does the manager have a track record? This is incredibly important.

“We are going to get barraged with a lot of different products but, truth be told, there are not a lot of managers out there who have a track record, so that will help eliminate a lot of choices out the gate.”

What are liquid alts?
Zyblock: “When you use the term alternatives, it’s a very broad category. If you think about alternatives you can bucket it into two universes: one is alternative assets themselves, commodities or currencies or real estate, and then there’s alternative strategies such as equity long/short, market neutral and global macro.

“Assets or strategies, I think ultimately what it boils down to is that people are talking about concepts that have low performance correlation to traditional investments like stocks and bonds. They do their own thing, they aren’t slaves to the rhythm of the equity market or bond market and that’s really what you are thinking about with alternatives. That is their benefit”

These views are not to be relied upon as investment advice nor should they be considered a recommendation to buy or sell. These views are subject to change at any time based upon markets and other conditions, and we disclaim any responsibility to update such views. To the extent this document contains information or data obtained from third-party sources, it is believed to be accurate and reliable as of the date of publication, but 1832 Asset Management L.P. does not guarantee its accuracy or reliability. Nothing in this document is or should be relied upon as a promise or representation as to the future.

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