Can diversified liquid alternatives offer pension schemes greater returns and diversification than traditional portfolios?
With some pension schemes moving away from the conventional diversification benefits of a mixed equity/bond portfolio, CAMADATA’s latest white paper on Diversified Liquid Alternatives (DLA) considers DLA as an alternative to obtain diversification and also considers the risks involved.
The whitepaper includes insight from guests who attended a virtual roundtable hosted by CAMRADATA in October, including representatives from Barclays, Barnett Waddingham, Isio, Law Debenture, Fulcrum Asset Management LLP, LGT Capital Partners and Partners Group.
DLA are designed to give pension schemes exposure to assets that can sometimes be hard to access, with the chief aim of finding sources of returns that are less correlated with equity markets. Traditional bonds are where this diversification has been found in the past, and for many portfolios it still is. But these ‘balanced’ portfolios are now under pressure.
The CAMRADATA whitepaper highlights in the Barclays Global Aggregate Corporate Bond Index, more than 40 per cent of the bonds are now rated triple-B, suggesting there is a significant equity-like risk in fixed income portfolios. A structural change like this is one of the drivers behind the move to DLA.
Sean Thompson, Managing Director, CAMRADATA, says: “There is an argument that the conventional diversification benefits of a mixed equity/bond portfolio are diminishing. Partly because low rates in government bonds have caused investors to substitute government debt with corporate debt, also known as ‘credit’.
“This, in turn, has led to ‘credit creep’ which refers to how the pressure to obtain yield means investors have bought more deeply into higher yielding corporate bonds, while reducing their exposure to safer government bonds. The result is more risk.
“Our panel explored if DLA really is a means to obtain diversification, in a safe and controlled way, and the complexity within these portfolios. The discussion considered this in the context of volatile markets that have recently tested all kinds of strategies.”
The CAMRADATA discussion began with attempts to define each of the three key elements in DLA strategies - the asset classes involved, the liquidity profile of underlying investments and crucially the sensitivity of returns to traditional asset classes.
The conversation then turned to risk and return objectives, before the investment consultants on the panel were asked whether now was the right time to allocate to alternatives, given the miserable yields on much sovereign debt and the high price of many equities.
The panel also discussed how some investors without the resources to deal with complexity looked for a one-stop shop for all alternative asset classes; communication and the need for greater transparency, especially when it comes to fees, before returning to the theme of illiquidity in the context of DC pensions.