When equity markets perform well, and interest rates are low, and there is a greater demand for riskier assets, investors turn naturally to traditional strategies such as long-only and ETFs funds. But, to go overweight equities is relatively speculative. This is why, a well-diversified portfolio is usually encouraged. Traditionally, when constructing a multi-asset portfolio, allocation to alternatives is circa 5%. With a much higher exposure, 20% to 30%, to alternative and uncorrelated strategies such as Equity Market Neutral (EMN) or statistical arbitrage, investors can easily optimise their returns and portfolio performance.
To sum up, EMN strategies generate performance when long positions outperform short positions, irrespective of the market environment, drawdowns are lower than in equities or traditional strategies, and the portfolio construction is neutral, long and short positions are equally weighted. And finally, when compared, EMN strategies and government bonds have both a volatility of circa 3% per year.
Figure 1 demonstrated that EMN strategies are less volatile and fully hedged compared to long-only strategies. For the past 45 years, the MSCI World index has a volatility of 15%, meaning long-only (or traditional) investors have faced extreme market swings. It supports and reinforces our argument that wisely-invested assets in market neutral funds can preserve wealth, ensure consistent return, and limit risk.
However, this can only be achieved if the asset allocation in market neutral strategies is at least 20%. The tightening of monetary policies and the increase in short-term rates should also have a positive impact on the investor’s choices to transferring assets from traditional to uncorrelated strategies.
Those investors are looking for stability and diversification. To that purpose, they should start investigating such alternative investments and educate themselves in market neutral and statistical arbitrage products. Those are valuable instruments so as to improve portfolio performance in the coming years, while traditional assets may not return that well or enough. It can provide the stability and performance sought after, regardless of Wall Street mood swings. In a low-interest rates and markets uncertainties environment, looking for alternative solutions to preserve and grow one’s wealth should be on everyone’s mind and priority.