Do the new market conditions spell new alternatives for your portfolios?

The Goldilocks environment of 2017 has given way to a slew of uncertainties that has impacted markets this year. Even if the US economy is going from strength to strength, trade tensions between the United States and China, post-Brexit negotiations in Europe, the rise of populism and tensions in the Middle East have created a degree of instability conducive to the return of risk appetite.

We now have to deal with new market conditions in which risk is making a gradual comeback, volatility is on the rise and certain asset classes are in decline. This renewed market volatility is probably making you seek tips on how to more serenely navigate these troubled waters.

A diversification strategy might be the first thing that comes to mind. This, however, is an approach that – in the past, at times of growing uncertainty – has been faced with recorrelating risk factors.

In other words, as all asset classes could decline simultaneously, it is not enough to construct decorrelated portfolios just by doing the math (calculating the correlation coefficient).

Integrating other asset classes such as private equity, real estate and infrastructures, all of which offer potentially attractive returns, was deemed another possible (partial) solution. These assets, with their long-term cashflow visibility, are less sensitive to market fluctuations as they are unlisted and protected against inflation risk. However, interest-rate hikes are impacting their financing cost and many of these strategies have cash that they are unable to invest, due to the shortage of suitable investments. And, of course, if these assets, like all other illiquid assets, can be difficult to obtain, the difficulties increase in the case of a compulsory sell-off.

Smooth navigation depends on finding assets that are, first of all, liquid, and that, secondly, provide markets a real decorrelation opportunity at all times and, thirdly, boost your portfolio performance in the medium term. An analysis of the average performance of absolute return strategies in comparison with economic cycles these past 20 years shows five strategies with a behaviour independent of our current environment of low economic growth and high inflation:

• Short Bias: net short portfolio on equity markets;
• Global Macro: long/short arbitrages across multiple asset classes, to capture inefficiencies generated by excessive market behaviours;
• CTA: portfolio that captures bullish and bearish trends on different markets;
• the Equity Market Neutral strategy, which combines long and short equity positions with a net neutral exposure;
• and, finally, Merger Arbitrage, as applied to M&A deals.

Combining these liquid strategies in your portfolio will help it withstand market upheavals and help you look forward to the months ahead.