Professional Adviser: Liquid alternatives in the eye of economic storms

The traditional 60:40 portfolio is struggling to deliver diversification, writes Rudy Koitchev. Here he explores why now is the time for advisers to think differently...

The last few years have been particularly challenging for UK advisers and their clients, testing strategies and client relationships like never before. In addition to managing continued uncertainty caused by unprecedented volatility, a number of challenges persist: an active geopolitical landscape, high inflation, and shifts in the global economic regime.

One of the toughest challenges has been navigating the shifting dynamics between stocks and bonds, disrupting the once-reliable 60:40 portfolio strategy.

As a result, the industry has seen an influx of wealth managers, asset managers, institutional investors, and family offices alike, increasing allocations to alternative investments in search of new strategies to diversify and balance risks. In fact, 85% of advisers expect to increase allocations to one or more alternative asset classes within the next year, according to research. 

While alternatives' popularity has skyrocketed, there's still a lack of understanding of alternatives and how different strategies can potentially lead to enhanced returns. Wealth managers have a tremendous opportunity to differentiate themselves by adopting alternative strategies that are tailored to meet investors' long-term goals. Liquid alternatives is an increasingly popular strategy that offers exposures similar to those found in private vehicles, such as hedge funds, commodities, or real estate — but in the form of liquid and regulated investment vehicles like mutual funds or ETFs.

Liquid alternatives offer many of the benefits of traditional alternatives, including diversification and inflation hedging, but with enhanced liquidity and transparency. Importantly, the ability to generate liquidity quickly, while complementing the 60:40 portfolio, can meet the investor demand for a personalised wealth management experience.

Diversify the portfolio

Liquid alternatives tend to employ non-traditional investment strategies and often exhibit low correlation to traditional asset classes, such as stocks and bonds, making them well-suited to help navigate economic uncertainties. They may have characteristics like steady income, inflation hedging, and the potential to mitigate against volatility, enabling advisers to access alternative return drivers and enhance portfolio resilience.

Hedge against inflation

Unlike most traditional asset classes, liquid alternatives can benefit from rising inflation by capturing price increases in commodities, currencies, or other inflation-sensitive assets. Importantly, liquid alternatives can also benefit from price declines (in bonds or equities, for example) by taking short positions. With the potential to hedge against various risks, portfolio resilience can be enhanced by diversifying with liquid alternatives during economic storms. This strategy may not only help support a portfolio from inflationary pressures, but also may enhance returns during periods of economic uncertainty.

Manage risk through increased liquidity

During the UK liquidity crisis in September 2022, the market faced significant liquidity risks and was thrown into chaos. Since then, investors have prioritised liquidity in their portfolios. Liquid alternatives provide the advantage of daily dealing, which can be especially valuable during times of uncertainty or volatility. This flexibility enables investors to better manage risk and reallocate capital to seize emerging opportunities. 

Benefit from regulatory protections

Liquid alternatives are typically offered as regulated investment products, such as UCITS funds. Unlike private alternative investments, regulated liquid alternative vehicles are often subject to  multiple constraints, including on leverage or volatility, liquidity, and concentration, to name a few. As a result, investors stand to benefit from greater transparency and certain regulatory protections. 

Traveling the road ahead

The traditional 60:40 portfolio is struggling to deliver diversification, and we believe now is the time for advisers to think differently.

Advisers must reconsider their investment strategies in order to effectively help their clients navigate the market's ups and downs, manage risk, and achieve long-term financial goals. Liquid alternatives may enable advisers to hedge against inflation and generate returns. They can be the answer to strengthening an investor's and a firm's resilience—and help to drive growth for the future.

Important information

The following information can be sourced to CAIS, Mercer:

• In fact, 85% of advisers expect to increase allocations to one or more alternative asset classes within the next year, according to research.

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