Building portfolio resilience with liquid alternatives

Matt Bullock (MB)

Hello and welcome. I’m Matt Bullock. I’m the Head of Portfolio Construction and Strategy for EMEA and APAC here at Janus Henderson. And today, I’m lucky to be joined by two guests from our Diversified Alternatives team. We have Rob Schimell and Mark Richardson. Welcome, guys.

Rob Shimell (RS)

Thanks, Matt.

Mark Richardson (MR)

Thank you Matt.

MB

So, you both spend a lot of your time going out talking to clients about the role of alternatives in portfolios, and in particular, the roles that they play in volatile markets, which is very relevant for the last few years that we’ve seen.

So, Rob, I might start with you. So, what have been some of the key areas of interest in your conversations, and what have been the main messages that you’ve been getting across?

RS

I think our kind of core message has really been that the macro environment we found ourselves today, but also post-Covid, is very much different to the macro environment we saw pre-Covid. And because of that, it makes sense for clients, investors, allocators to reconsider their asset allocation given the change in the macro regime and our kind of contention is that we believe systematic strategies, and what we mean by that is sort of CTA trend following, commodities long short absolute return strategies, they have a key role to play as portfolio diversifiers at a time when, you know, traditional diversification, the equity bond correlation, is increasingly positive. And so we think allocating to systematic strategies is potentially a good way to increase diversification and build portfolio resilience.

MB

Okay, so I know that describing the approaches that you employ within alternatives, it can get quite technical can’t it. So, can we, could you just give us a high-level view of why these strategies suit the current environment? Mark, if I could start with you.

MR

Sure. So, I mean, I think the first thing to say is, one of our jobs as portfolio managers is to be able to explain these concepts simply because ultimately they are simple exposures. Now, that doesn’t mean there isn’t going to be some technical detail involved in construction, that’s part of the art of constructing systematic strategies.

But ultimately, it’s a straightforward exposure. If you’re talking about, for instance, CTA trend following this is a canonical systematic strategy. It’s one of the oldest quant strategies. It’s been around in one form or another for perhaps hundreds of years, but certainly in its modern form, it’s been around for around 50 years, and it’s typically implemented by trading futures, global cross asset futures, on a long, short basis.

And it’s an extremely powerful strategy in the context of an asset allocation. And the reason for this is because it can go short as well as long. That’s the fundamental clincher. And it’s an adaptive strategy, meaning that it auto tunes itself to market conditions. And the essence in trend following is you look for things that are going up and you buy them and you look for things that are going down and you sell them.

And if you do that on a systematic basis the money you make, the return stream it delivers that is, is pretty well uncorrelated to standard risk assets. So, this means that it looks very, very good if you start combining it with standard risk allocations, equities, bond or the 60/40 portfolio.

And really, the way to look at CTA trend following is as a kind of tail risk hedge. So, when the world is going wrong and, you know, from time to time that does happen to the world, and it’s happened before it’s going to happen again. If you’ve got this in your portfolio, it’s a very powerful thing to have.

MB

Rob, anything to add?

RS

I mean, I can talk more specifically about commodities. You know, it’s an asset class, which really, I guess came to the fore in the mid-2000s when we had the last commodity supercycle. Commodities, they have different return streams to equities and bonds. They’re real assets. And because of that, again we think they’re valuable from a portfolio diversification perspective.

And specifically, they can do very well during supply shocks like we’ve seen this year and during inflationary periods. So, if you’re looking to build a kind of all-weather portfolio, which can kind of perform well during multiple different macro regimes, commodities can play a key role there.

The other thing they give you is they give you a sort of exposure to a lot of the megatrends we see in the world today. So, things like, you know, AI data centre build out, the energy transition, huge increases in defence spending, dollar debasement. And what we’ve seen over the past 10/15 years is that sort of real capital expenditure in the energy space and the material space, has actually fallen. And so, we’re at this kind of juncture in the world where we have huge demand increase going forward across metals, across energy, and we have supply, which is really kind of struggled to catch up.

And that’s why we’ve seen record highs in a number of commodities. And so again, protecting against inflation, building portfolio resilience, and having a kind of attractive outlook for the asset class.

MB

So you’re both working what we define as liquid alternatives. And you know a lot of times the question comes up about what is the difference between the liquid and things like privates or illiquid alternatives? So how do you make that distinction? And then how do you think clients should think about the role of liquid alternatives in a portfolio?

RS

So, I mean, I guess the answers in the name. So obviously one of the key differences is liquid alternatives are liquid. So, if you look at sort of systematic trend following, commodities, long short equity market neutral, you’re typically trading highly liquid instruments. And so, you have the benefit of often being able to, if you’re a client or investor, transact on a daily basis, daily liquidity.

And, you know, I always think about liquidity, as Warren Buffett said, it’s like oxygen. You only really notice it when it’s not there. And so having that liquidity in a diversifier, we think is an additional benefit. Mark already talked about the transparency and in some cases the simplicity of the strategy. It’s relatively easy to understand, at least in principle, what a commodity strategy or a trend following strategy or an equity market neutral strategy is doing. And then again, I think if you look for what is the true diversification power, as Mark said, it’s the ability to go short as well as long. Arguably private equity or private credit exposures, there is some exposure there to credit beta and to equity beta, whereas the ability to go short is very, very powerful. And you get that in alternative markets. And therefore, they often deliver a kind of correlation profile, which is uncorrelated to traditional asset classes like equities and bonds. And furthermore, you can actually get diversification when you most need it and liquidity when you most need it.

So we think the kind of those combinations for simplicity, the transparency, the daily dealing, the ability to go short are incredibly valuable. And it’s why increasingly we believe alternatives are going to be, or liquid alternatives, are going to be part of investor toolkits.

MB

So as an alternatives team, you run billions of assets under management across a range of different strategies. But Mark, if I actually ask the question to you, which is what would you say are the highest conviction views for the next six months?

MR

Well, look, I guess I’d, I quote one of the founders of quantum mechanics, Niels Bohr, who said prediction is difficult, especially about the future – that is also attributable sometimes to Yogi Berra. But really, it’s an important thing to bear in mind because you know we’re not really in the game, as it were, in systematic strategies of making, you know, gun slinging, you know, shoot from the hip bets.

What we’re focused on is process. And we’re focused on building robust, systematic programmes that operate on a basis that we specify upfront in the initial research process. And we get to the point when designing a strategy and designing a portfolio allocation system, whereby we are sufficiently happy to then let it run.

Now, if you are managing a systematic strategy and you’re finding that there’s a need for overrides, that’s suggestive that there’s something that needs to happen at the model stage. So really, I wouldn’t say that convictions per se is the way that we look at things. What we instead look at is continuing to iterate on models that we’ve built and making sure that the portfolio construction process is sound and that we have the right data inputs, that we’re staying abreast of the latest technologies. And we’re embracing, for instance, AI tooling and leveraging that, where appropriate, to enhance the model and enhance the process and ultimately enhance the experience of our clients.

MB

Great. Well. Just a quick-fire question now just to finish it off. So, what would you say are the key attributes to successful investing in the alternative space. So, Rob, if I start with you?

RS

Yeah, sure. So I mean, I think it’s a number of different things. I mean, I think it’s easy to say, well, you can just run quantitative strategies in a vacuum, but we believe having the underlying kind of deep market depth and knowledge and insight into the asset classes and trading is very, very important. But combined with that, we think it’s all about the quality of the quantitative research and development you do.

We spend a lot of time on signals, but also on how we combine the signals. So portfolio construction, risk budgeting. And I do think that is one of the key differentiators between systematic strategies and fundamental discretionary strategies where often in the latter the focus is really on picking the instrument, whether it be a fixed income instrument or an equity.

We spend a huge amount of time thinking about, well, how do we combine everything? How do we allocate across different risk dimensions, and how do we protect drawdowns and build resilient portfolios. So, I think all of those put together are important.

MB

Mark?

MR

You need good data. You need good data. You need good systems, and you need good processes. You need to have a wide range of technical expertise. That’s the top-level macro constraint, if you like, that applies to a team.

But then on an individual level, you need an intellectual curiosity, and you need a technical mastery. And you need to be rigorously focused on finding the next opportunity and not being satisfied with the current state of affairs, always pushing the boundary to the next level, whether it’s on the level of the individual strategy, trying to make it better, trying to improve individual strategies, or finding the next big thing.

MB

Great. Well, Mark, Rob, thank you so much. I mean, this is a topic we’re going to hear a lot about, especially as there’s so much volatility out in the marketplace. So, with that, I’d like to thank the audience very much for listening.