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By DailyAlts Staff Alternative strategies aren’t a homogeneous bunch. Due to their generally unbenchmarked nature, alternative funds within the same category can vary greatly in terms of their objectives, strategies, and risk/return characteristics, to say nothing of the wide diversity of funds and strategies across the universe of alternative styles. In a new white paper titled ” Alternatives in action: A guide to strategies for portfolio diversification ,” Putnam Investments’ Christian Galipeau, Brendan Murray, and Seamus Young set out to answer two questions: What are reasonable performance expectations for alternative investment strategies? How can these strategies fit into a portfolio of traditional assets? For their study, they looked at four alternative categories over the past 20 years, breaking those categories down into sub-styles where appropriate. Their findings: Not surprisingly, different strategies have performed better under different economic scenarios, but funds from the “Risk Reducer/Volatility Dampener” category – such as multi-strategy and global macro funds – have had the most consistent risk-adjusted returns over the past two decades. Classification of Styles For purposes of their analysis, the Putnam Investments authors break alternatives into four broad categories: Return Enhancers Inflation Hedges Risk Reducer/Volatility Dampeners Zero Beta/Zero Correlation The authors then look at how each category has performed under various economic environments over the past 20 years. For the Return Enhancers category, they look at the performance of the Cambridge Associates US PE Index as a proxy for private equity (“PE”). For Inflation Hedges, their benchmark is the S&P GSCI Gold Index Total Returns, as a proxy for precious metals. The Risk Reducer/Volatility Dampeners and Zero Beta/Zero Correlation categories are split into two and three sub-styles, respectively. The former includes multi-strategy and global macro funds, as measured by the Credit Suisse Hedge Fund Index for each style; and the latter includes managed futures, market neutral, and convertible arbitrage funds, also represented by Credit Suisse benchmarks. Future Economic Scenarios “Understanding how different alternative strategies may behave in different environments is essential to utilizing alternatives as an effective source of diversification over market cycles,” the authors write. They look at the performance of each style and sub-style over the period from 1994 to 2013, across four economic scenarios [Growth (G) / Inflation (I)]: G+/I+: Above-trend economic growth with above-trend inflation. G+/I-: Above-trend economic growth with below-trend inflation. G-/I+: Below-trend economic growth with above-trend inflation. G-/I-: Below-trend economic growth with below-trend inflation. As shown in the image above, “G+/I+” has been the most common scenario over the 20 years ending with 2013, but it isn’t necessarily likely to be the most common over the next 20. Performance Under Different Cycles Global macro funds provided the best risk-adjusted returns under G+/I+, G-/I+, and G-/I- scenarios – only the rare and unlikely G+/I- (high growth/low inflation) scenario did another style outperform global macro on a risk-adjusted basis, in this case private equity. The image below shows the risk-adjusted returns of all the strategies under review, as well as traditional assets, over the 20 years ending in 2013: But when using alternatives within a portfolio, another important consideration is how the strategies correlate with other assets in the portfolio. Not surprisingly, the Zero Beta/Zero Correlation sub-styles performed best in these terms, with market neutral funds having the lowest equity beta and correlation under the G+/I+ scenario, and managed futures earning that distinction under G-/I+ and G-/I- scenarios. In closing, the authors state that their study confirms that “alternative strategies can represent valuable innovations to the toolbox of portfolio choices.” Further, “in specific types of economic periods, the performance of some alternatives can diverge from their long-term characteristics.” Scalper1 News
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