With the Federal Reserve getting closer to raising interest rates, perhaps as soon as year-end, advisers should consider allocating to liquid alternative strategies to buffer clients' portfolios, according to a panel of investment executives on Wednesday.
Although there have been continual delays on such a move by the Fed to hike rates, there will ultimately be action and advisers would do well to start taking that into account before Fed chairwoman Janet Yellen makes an announcement, according to panelists.
“I think the planning time is now to address it,” Peter Lowden, chief investment officer at The Enrichment Group, said at the fifth annual InvestmentNews Alternative Investments Conference in Miami.
The Fed announced Wednesday that it would keep interest rates at near-zero levels, but kept open the possibility of raising the target rate during its next meeting in December.
Charmaine Chin, managing director at K2 Advisors, echoed that sentiment, saying that with quantitative easing coming to an end, she's expecting a much more volatile credit and interest-rate environment. Even if advisers don't expect rates to rise soon, markets have proved volatile just due to the threat of a rate rise, she added.
“I think alts is one area a lot of our clients have been interested in because they anticipate this rate increase,” Ms. Chin said.
“A return to normal is going to seem pretty nasty,” according to Richard Brink, managing director of alternatives and multi-assets at AllianceBernstein. Alts are meant to decrease volatility, so an allocation to alts in a client portfolio help smooth returns, he added.
Mr. Lowden allocates to alts strategies — long-short credit, managed futures and multi-strategy funds, for example — from the fixed-income bucket of client portfolios. Alts can deliver high risk-adjusted returns, but there's a greater likelihood the return will be lower than that of the equity market, whereas you'd see that far less often with fixed income, Mr. Lowden said.
Ms. Chin recommends allocating 10-15% to alts to enhance downside protection and diversification. However, “whether you take it out of equites or bonds I think really depends on your risk-return preference,” she said.
For example, maintaining the risk profile of a standard 60-40 equity-fixed income portfolio would call for pulling 10% from equities and 5% from fixed income and putting that toward an alts bucket, according to Ms. Chin.
However, she added that clients who've allocated purely from the fixed-income side have generally been happier with their decision, because the return stream delivered by alternatives funds has been much more similar to that of fixed income.
Using a multi-strategy fund resonates well with advisers allocating to alts for the first time, because they don't have to parse through different types of investment strategies and the funds are built with between 10 and 20 hedge funds, Ms. Chin said.
For those advisers desiring more customization, strategy-specific funds — a credit-focused mutual fund, for example — could be a good fit.