Markets in 2017 are poised to land a one-two punch of expensive stocks and low-rate bonds. With stocks trading at 18X forward earnings,1 the S&P 5002 could be considered pricey. But the expense isn’t isolated to the U.S.
Valuations this high may suggest the odds of a runaway bull market are not great. Bonds have their own challenges. With interest rates low, yields – or the income return on bond investments – may be insufficient to offer a cushion against principal losses if rates rise. So where do investors go?
Investors see a need for alternatives
In examining the options for risk reduction or return enhancement, a little research may lead to alternative investments.3 Many investors see the need to fill some of the key roles alternatives play in a portfolio, but they need to know more before they invest. A majority say they want new strategies that are less tied to the broad markets (71%), that help insulate their portfolio from volatility (74%), and that help them to better manage risk (77%).4
Almost half (46%) say they already invest in alternatives. Those individuals who don’t invest in alternatives express concerns that demonstrate the need for more education about alternative strategies. Half say alternatives are too risky, and nearly a third say they don’t understand how they work. Taking the alternative route with these investors may require explaining the investment, its potential risks, and its function in a portfolio. This is something advisors believe they have worked out, as over 75% in the U.S. say they rely on liquid alternatives in portfolio construction to fulfill a number of critical portfolio functions.5
Review investment priorities
Many alternative investments have struggled in recent years as a result of the outsized influence of monetary policy and low dispersion6 among security returns. If interest rates and inflation increase, this may create a more hospitable environment for alternatives.
Recognizing that alternatives may take renewed importance in 2017, it may also be a good time for advisors to revisit their go-to strategies and reaffirm that the investment thesis for each still holds up.
Our Moderate Portfolio Peer Group (MPPG) shows that diversification is paying off for advisors.7 Since the market drawdown in August 2015, the best-performing portfolios in this peer group were the most broadly diversified, with the largest share of non-correlated assets. Most recently, our MPPG research suggests that some advisors are shifting allocations to risk-reducing strategies.
Managed futures may indicate this shift to risk-reducing strategies. They now account for over a third of alternative allocations in our Moderate Portfolio Peer Group as of September 30, 2016, a dramatic increase from just over 10% two years ago. The risk reduction play may be paying off, as we’ve seen that 60% of the time, portfolios with alternative allocations over 10% have had a better Sharpe ratio8 compared to portfolios without alternatives.
Putting the strategy to work
Advisors can consider examining portfolio positioning to determine the role of your alternative holdings: risk management or return potential. Knowing that advisors have been shifting alternatives allocations to enhance risk management, consider which will best fit the bill when equities may potentially be volatile.
Clients want better risk management but you may still need to educate some on how alternatives may fit this portfolio function, making this a vital part of the discussion.
1 Forward earnings – A company’s estimated earnings, as determined by analysts or the company itself. This figure is a projection and not a fact.
2 The S&P 500® Index is a widely recognized measure of U.S. stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large-cap segment of the U.S. equities market. You may not invest directly in an index.
3 Alternative investments involve unique risks that may be different from those associated with traditional investments, including illiquidity and the potential for amplified losses or gains. Investors should fully understand the risks associated with any investment prior to investing.
4 Natixis 2016 Global Survey of Individual Investors – Natixis Global Asset Management commissioned CoreData Research to conduct a global study of individual investors, with the goal of understanding their views on the markets, investing and measuring their progress toward financial goals. Data was gathered throughout February and March 2016. The study included 7,100 investors in 22 countries including 750 in the U.S.
5 Natixis 2016 Global Survey of Financial Advisors – Natixis Global Asset Management commissioned CoreData Research to conduct the study of advisors in 15 countries in order to assess advisor attitudes on a range of topics such as business growth, portfolio construction (including volatility, risk and income), client service, advice and investment challenges. An online quantitative survey was developed and hosted by CoreData Resarch. A sample of 2,550 advisors in 15 countries including 300 in the U.S. was obtained for the purposes of this study. Results are analyzed with segmentation from a range of perspectives.
6 The term dispersion describes the size of the range of values expected from a particular trading strategy. It is sometimes used to measure the degree of risk associated with a particular security or investment portfolio.
7 U.S. Moderate peer group consists of 2377 portfolios submitted to PRCG from Jan 2013 to Sept 2016. Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results. Source: Natixis Global Asset Management Portfolio Research and Consulting Group.
8 The Sharpe ratio is a measure that indicates the average return minus the risk-free return divided by the standard deviation of return on an investment.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
Diversification does not guarantee a profit or protect against a loss.
Alternative investments involve unique risks that may be different than those associated with traditional investments, including illiquidity and the potential for amplified losses or gains. Investors should fully understand the risks associated with any investment prior to investing.
Managed Futures use derivatives, primarily futures and forward contracts, which generally have implied leverage (a small amount of money used to make an investment of greater economic value). Because of this characteristic, managed futures strategies may magnify any gains or losses experienced by the markets they are exposed to. Managed futures are highly speculative and are not suitable for all investors.
Volatility management techniques may result in periods of loss and underperformance, may limit the Fund's ability to participate in rising markets and may increase transaction costs.
Understanding current market conditions and what might be expected in the near term.
Moderate model portfolio performance in 2016 was a tale of two halves.
Discussing the causes and potential consequences of the UK’s "Leave" vote.