Alternatives Forum
i3 Alternatives Forum | Investment Innovation Institute

Alternatives Forum

Hidden Correlations

Without doubt, the redback spider is one of the most dangerous creatures in Australia.

The potency of its venom is obvious, but what’s less known but potentially more dire is its preference to live in and around human habitats!

Statistics indicate that the distribution of redback spiders in Australia correlates well with populated areas, with only a small proportion found outside urban areas.

Can we reduce that correlation? How should we humans minimise the risk of living with these ‘hidden housemates’?

The Decline of the Equity-Bond Correlation

The negative correlation between equities and bonds, which has served 60/40 portfolios so well for the past decade, is now questionable. The new investment regime, exacerbated by the pandemic, has somewhat diminished the defensive role of bonds.

Is there an alternative to bonds, or so-called bond-substitutes?

Innovation in Hedge Funds

Australian sociologist Alfred Winslow Jones (1900-1989) was widely acknowledged as the ‘father of the hedge funds’ industry, when he created the first fund structure to hedge investment risk due to market movements.

Since then, the hedge fund industry has expanded to include a plethora of techniques and structures. These may include market neutral, global macro, relative value, merger arbitrage, trend following, alternative risk premia and a host of esoteric strategies across the liquidity spectrum.

Unfortunately, market crises come in different shades too. Each crisis, whether the global financial crisis of 2008 or the current pandemic-induced one, has exposed the weaknesses of individual strategies and the lack of persistent performance.

Recent innovations include a multi-strategy approach, dynamically blending a range of short and medium-term tilts across the market cycle. These may include volatility management, derivatives overlays and portable alpha strategies.

Blurring of Public vs Private Markets

Disruption and changes in market structure have also distorted the traditional delineation of public and private markets. With companies staying private for longer, investors will need to consider the lifecycle of companies and how to best capture the alpha opportunities – whether in public or private equity, or the crossover gaps.

Flushed with significant liquidity, pension and sovereign funds are also considering how best to capitalise on the mispricing of public vs private assets, including initiating public-to-private transactions.

The withdrawal of banks in the direct lending space has created a structural opportunity for private credit as an enduring asset class too.

Portfolio Construction

While the role of bonds has traditionally been as an anchor and diversifier of equity risk, alternatives aim to achieve much more. Depending on the underlying characteristics and implementation approach, alternatives may be used for downside protection, alpha capture, alternative yield, or a combination.

We look forward to uncovering the fascinating world of alternatives at the annual [i3] Alternatives Forum 2022.