We increasingly find ourselves looking to alternative investments, and alternative investment strategies as another way of mitigating equity risk in portfolios.
Listen to On the Minds of Investors
The past few weeks have seen an increase in market volatility, as investors have focused on the reacceleration in case growth across Europe and the inability of policymakers to come up with another fiscal package in the U.S. The bottom line is that additional fiscal stimulus is necessary to keep the recovery on track, but Congress remains unable to strike a deal. While further deterioration in the economic data may force their hand in the coming months, this dynamic is complicated by the upcoming Presidential election.
Offsetting some of this stress is the fact that monetary policy is as dovish as can be. The question, however, is whether central bankers will succeed in generating higher rates of inflation. Despite a formal shift to average inflation targeting, Federal Reserve (Fed) forecasts suggest inflation will not reach 2% for three years. When viewed in this context, recent volatility makes sense – policy has led us out of the deepest recession in more than fifty years, but its efficacy going forward is being called into question. Until there is more clarity on this, as well as the issues surrounding fiscal policy and the virus, markets will be choppy.
So how can investors deal with this volatility, particularly against a backdrop of very low high quality bond yields? Although U.S. Treasuries remain one of the best ways of diversifying equity exposure, we increasingly find ourselves looking to alternative investments and alternative investment strategies as another way of mitigating equity risk in portfolios. As we highlight in our Guide to Alternatives, core real assets like real estate and infrastructure can provide both diversification and income, while certain types of hedge fund strategies can zig when the stock market zags. Turning to more liquid assets, equity strategies that use options to hedge their market exposure, as well as absolute return fixed income strategies that are benchmark agnostic, can act as an additional buffer against market volatility.
At the end of the day, the lack of fiscal stimulus, looming Presidential election, persistent presence of the virus, and unresolved US/China relations will keep volatility elevated into the end of the year. The key at the current juncture is to recognize that volatility is normal but markets are resilient; investors should ensure that their portfolios are structured in such a way that they will be able to remain invested during this period of elevated volatility, and subsequently participate in the upside that capital markets have to offer over the longer-term.
Market volatility has increased in recent weeks
CBOE market volatility index (VIX)