Using liquid alternatives to enhance client portfolios

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1. What's your view of markets today?

2. Given what you have said - what strategies do you consider most relevant?

3. How have these developments affected the way you are investing? You mentioned downside protection for example. Is that achievable?

4. How can clients generate income today?

Video transcript

1. What's your view of markets today?

Look, we've probably entered a period here of heightened volatility. Clearly there's a lot of geopolitical issues going on around the globe, supply chain issues and inflation. And I think a lot of it started the latter part of last year. So, that's going to translate into probably a more moderate market. We've obviously had a pretty large sell off so far, but instead of sort of V type recovery, it's more likely that we're going to see continued volatility as we work through the geopolitical issues, as we work through the inflation and as well as some of the supply chain issues.

2. Given what you have said - what strategies do you consider most relevant?

I think the types of strategies that are relevant to clients, one is what type of strategy is going to do well in that more moderate type of market, moderate choppy market. And I tend to sort of bucket moderate in that zero to 12 and then obviously less than 12 would be the selloff type market and that's where I think we're more likely heading. As opposed to the last five years, we've had predominantly markets that have been greater than 12% annualized results. The type of strategies I think that are relevant in that are defensive type strategies. So, within equities, long short equity. If you're invested in equities, probably more of a tilt towards value-oriented strategies, as opposed to sort of growth at any price, which is what we've seen. And also, strategies that have low correlation to traditional markets like stocks and bonds.

3. How have these developments affected the way you are investing? You mentioned downside protection for example. Is that achievable?

In a hedged equity or strategies that designed to provide downside protection, this type of environment's obviously quite good for it. So, yes, we've been able to provide downside protection. Our systematic strategies tend to favour factors, factors like value and quality, momentum in a more moderate type of environment, it's more of a stock picking market. Where over the past, call it, five years prior to sort of the end of 2021, investors were less interested in factors. Like I mentioned before, it was growth at any price if you will. Whereas when you're in that more moderate market there is a focus on stock selection, active management is much more important. And as a result, strategies like our quantitative strategies that do tilt towards these fundamental factors like value and quality have done quite well. So, there's been quite a bit of a turnaround in terms of which factors are driving the markets today. What makes our approach different in terms of how we do our downside protection is the way that we structure our portfolio. We like to short high beta stocks as a way of providing downside protection. In the long run our expectation is those high beta stocks tend to have low, long term expected return versus the markets. It's sort of, if you're familiar with the low volatility anomaly which sort of suggests that low beta stocks keep pace with high beta stocks, it sort of takes that concept to the next level. A lot of people harvest the low vol anomaly by buying a portfolio in the long concept of just low beta stocks. But a more elegant approach of harvesting that premium is to short high beta stocks. Now, obviously if you're shorting high beta stocks, you don't want to short too many of them because when the markets turn, that can be quite a bit of a headwind. So, the way that we build that portfolio is we go long $100 of stocks that are pretty close to beta one or market like it's about a beta 0.9 on the long side. And then we short about $30 of high beta stocks. Now these aren't just high beta stocks, these are stocks with high beta and very poor fundamentals. And so, you can appreciate if the market sells off, those stocks tend to fall quite quickly, oftentimes more than their beta would suggest. And as a result, it provides a really nice cushion to the portfolio. So, this year's a great example of that. You'll see some of the high beta stocks selling off dramatically providing that downside protection that our clients are looking for in the portfolios.

4. How can clients generate income today?

Having a portfolio that's tilted towards more of those defensive type sectors tends to do quite well. We run a product called global equity enhanced income, which is an ACWI-based strategy. It tilts towards higher yielding stocks, yet it goes one step further. So, we actually target the equity portion to have about 2% higher yield than say the ACWI index. But then on top of that, we use options to enhance the income further. So, the strategy's designed to deliver about a 6% income. It actually pays out about 1.5% per quarter, and that strategy is designed to deliver market like results, but with enhanced income. And that's the strategy we're seeing quite a bit of interest in today globally.

More videos from George Matthews, Allspring Global Investments

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