Alternatives Outlook
Building a Portfolio Robust to Significant Macro Shifts
As we enter into a period of potential divergence, the importance of diversifying return drivers will be more important than ever. Predicting the winners and losers as economies diverge from one another is no easy task. Our job in manager selection within alternatives is not so much to forecast which sectors or geographies are expected to outperform, but to ensure that the portfolio is robust to any significant shifts in the macroeconomic environment. To achieve that, we have a portfolio which is balanced across geographies, return drivers, sectors and asset and strategy types.
Diversified and Diversifying
The alternatives portfolio’s role is to be diversifying to the other assets in our multi-asset portfolios. Greencoat and INPP would be supported by European and UK rates going lower and are largely immune to the path of US rates.
This need to be both diversified and diversifying is why we have allocations across infrastructure, option selling, trend following, alternative credit, discretionary macro and natural catastrophe insurance. We look to balance the portfolio across strategies which will capture some upside if markets experience growth, some that are more protective on the downside and others that have no real sensitivity to market direction.
Upside Capture
One strategy that could pick up some directional market exposure is trend following (Dunn). This strategy (explained in ILIM Spotlight) looks to capture price momentum by getting long or short as price trends emerge. If US stocks continue to trend upwards and outperform other markets, trend followers are likely to be long those US indices relative to the rest of the world. This is certainly true of their positioning at the time of writing but can change as price trends shift.
Protecting on the Downside
Some strategies, such as infrastructure, have bond-like characteristics and are expected to have some sensitivity to the path of interest rates. Greencoat and INPP would be supported by European and UK rates going lower and are largely immune to the path of US rates. Our global infrastructure fund provides geographical diversification, with exposure across the US, Europe and emerging markets.
Other strategies are positioned differently and should perform well if the path of divergence leads to the US underperforming. Macro manager Ruffer has increased its defensive stance based on Trump’s election, citing the risk of ‘greater fiscal profligacy’ not just in the US, but also in the UK following recent stimulus. They have buttressed their portfolio with protective securities such as short-dated bonds and an allocation to gold and other precious metals and are keeping their equity allocation scaled back. Meanwhile, GMO’s value focus means they continue to see the US as historically expensive and position their equity allocation away from US large caps, towards cheap EM stocks and a long-short deep value portfolio.
Something Completely Different
And finally, elsewhere we make sure to allocate to strategies such as insurance-linked bonds, which are earning a very different risk premium, namely the coupons paid by insurance companies to provide reinsurance against natural weather events. While the biggest issuers are US entities and these funds are exposed mainly to US weather events, they are not linked to the health of the US economy. Yields remain in double digits, so the strong performance of these managers over the last two years can continue into next year.
The alternatives portfolio is both diversified and diversifying and that is entirely by design. In building such a portfolio, it pays to have many paths to success and avoid replicating exposures that exist elsewhere in the portfolio. We believe alternatives are in a strong position to add value within a multi-asset portfolio in 2025, especially given the uncertainty and wide range of scenarios ahead.
ILIM Outlook 2025 - Alternatives
