Looking Beyond Traditional Asset Classes
Two areas where investors often fall short in diversifying their portfolios involve a home-country bias and an underinvestment in alternative betas. Today, we’ll address the second issue.
Alternative betas are the betas generated from a general exposure to non-traditional investments, such as hedge funds, private equity, or commodities.
However, many investors only utilize traditional asset classes, and by limiting their opportunity set, may end up with more volatile or less efficient portfolios than is necessary. Of course, investing is not a one-size-fits-all endeavor.
Now that the bull market is in its ninth year, it is easy for some to forget about the ups and downs that inevitably come with investing. Here you see the performance of the S&P 500 Index on the left most bars during the deep bear markets of 2000-2002 and 2007-2009.
The orange bars represent Hedge Fund performance, the gray bars Market Neutral strategies, and the green bars Merger Arbitrage. These alternative strategies held their value much better than the stock market during these volatile times.
Alternatives Have Helped Manage Volatility During Difficult Periods
Source: Morningstar, 12/31/16. Stocks are represented by the S&P 500 Index. Hedge Funds are represented by the HFRI Fund Weighted Composite. Market Neutral is represented by the HFRI Equity Market Neutral Index. Merger Arbitrage is represented by the HFRI Merger Arbitrage Index. Past performance is no guarantee of future results. An investment cannot be made directly into an index. A drawdown is the peak to trough decline during a specific record period of an investment.
One of the benefits of alternatives is that they may enhance portfolio diversification. Here you can see that the aforementioned strategies previously mentioned have correlations of 0.29 to 0.77 versus stocks and almost no correlation to bonds, which might prove beneficial if interest rates rise over time.
Alternatives Have Displayed Low Correlations Compared to Stocks and Bonds
Source: Morningstar, 1/1/00 – 3/31/17. This table shows the correlation of various alternative investment strategies to stocks and bonds, as measured by three HFRI Indices, the S&P 500 Index, and the Bloomberg Barclays U.S. Aggregate Bond Index, respectively. Measured on a scale of ‐1.0 to +1.0, a correlation of +1.0 means two investments move in perfect tandem with each other, whereas -1.0 means that one investment will move by an equal amount in the opposite direction from the other. Past performance is no guarantee of future results. An investment cannot be made directly into an index.
All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against a loss in a declining market.
The information contained herein is general in nature and is provided solely for educational and informational purposes. New York Life does not provide legal, accounting, or tax advice. You should obtain advice specific to your circumstances from your own legal, accounting, and tax advisors. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report, are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in this material will be realized.
Alternative beta is the concept of managing volatile “alternative investments,” often through the use of hedge funds. Alternative beta is often also referred to as “alternative risk premia.” Hedge funds are alternative investments using pooled funds that employ numerous different strategies to earn active return, or alpha, for their investors. Private equity is capital that is not noted on a public exchange. A commodity is a basic good used in commerce that is interchangeable with other commodities of the same type; commodities are most often used as inputs in the production of other goods or services.
The S&P 500 Index is widely regarded as the standard for measuring large-cap U.S. stock-market performance. Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade or better fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities, with maturities of at least one year. Hedge Funds are represented by the HFRI Fund Weighted Composite Index, an equal-weighted index that includes over 2,000 constituent hedge funds which have at least $50 million under management or have been actively traded for at least 12 months. There are no fund-of-funds included in this Index. Market Neutral is represented by the HFRI Equity Market Neutral Index, which consists of equity market neutral strategies that employ sophisticated quantitative techniques of analyzing price data to ascertain information about future price movement and relationships between securities, select securities for purchase and sale. Merger Arbitrage is represented by the HFRI Merger Arbitrage Index, which consists of merger arbitrage strategies which employ an investment process primarily focused on opportunities in equity and equity related instruments of companies which are currently engaged in a corporate transaction.
MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed through NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302, a wholly owned subsidiary of New York Life Insurance Company. NYLIFE Distributors is a Member FINRA/SIPC.