PORTFOLIO INSIGHT


encouraged to take on too much risk, and constrained


underlying liquidity suggests that even a relatively mild cyclical downturn could have an oversized adverse impact on finan- cial markets. At the present time, major economies around the globe are facing significant headwinds, particularly with regard to global trade, in relation to which frictions, and pressure on sup- ply chains, are intensifying. Meanwhile, the benefit of cycli- cal improvement in employ- ment has already occurred.


THE CASE FOR ABSOLUTE RETURN In our view, the challenge for all investors’ returns remains how this cycle ultimately unfolds. As already noted, we strongly believe that persistent cheap money has ‘costs’ in terms of distortions. This throws up the prospect of much lower (or even negative) returns in the short term but would also present opportunities and sig- nificantly improve the longer-term expected return for those investors who can preserve capital and be patient.


The challenge for the absolute strategy is to beat an upward-only target (which, impor- tantly, is not investable in passive terms) in the longer term. Whereas relative investors tend to be fully committed at all times, the absolute strategy will attempt to balance participation (in a whole range of asset classes) and capital preservation in a dynamic way through the cycle. The key aim is to create an asymmetric return pro- file by capturing some upside and dampen-


ing the drawdowns that are so damaging to the arithmetic of longer-term returns. An unconstrained multi-asset, global and highly active strategy has the ability to be tactically flexible and opportunistic in a way that those strategies that rely principally on


As it turned out, the


credit crisis was in fact the catalyst for an historic bull- market run.


passive diversification cannot. Structuring a portfolio around a stable core of predomi- nantly traditional return-seeking assets and an insulating layer of ‘stabilising’ assets can help to set a balance between participa- tion and capital preservation, with the aim of maximising the upside potential when markets rise, while limiting the downside risks when they fall.


THE TOOLS IN THE TOOLBOX In addition to global equities, a dynamic absolute-return strategy can be exposed to a broad range of assets in the ‘risk space’, including corporate credit and emerging- market sovereigns. ‘Alternative’ invest- ments such as infrastructure, renewables, real-estate investment trusts and aircraft leasing can provide uncorrelated return streams. Following a holistically constructed


single-portfolio approach,


based primarily on holdings of individual securities, means there is no obligation to


invest in all asset classes at all times. Instead, one can take a selective and specific approach to investment in different asset classes on the basis of their underlying investment characteristics. It is possible to alter the ‘style’ or characteristics of posi- tions in an asset class as the backdrop changes, rather than just the weights. Likewise, ‘wish lists’ of attractive securities can be activated when price levels change.


‘Stabilising’ assets in a portfolio can be used either to dampen or increase the volatility and per- ceived equity risks, based on the stage of the market cycle. Derivatives such as short futures can be used as a direct hedge and can be accretive to returns in periods


of market stress. Government


bonds can be positioned as an indirect hedge to falling equity markets, while pre- cious metals such as gold could provide a safe haven during tough economic times. In summary, we would contend that the flexible nature of such a strategy enables clients not just to access different return sources within a single portfolio, but also to benefit from the ability to navigate a chal- lenging market backdrop as the potentially toxic combination of deteriorating funda- mentals and lofty


valuations threatens


major drawdowns in asset prices. Such a strategy could be used as an insurance pol- icy and a diversifier, while it could also be used tactically as part of an overall portfolio allocation to adjust risk levels, without giv- ing up the optionality on sizeable capital growth through the cycle.


Issue 86 | September 2019 | portfolio institutional | 43


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