The prolonged low-interest-rate environment is forcing
institutional investors to come up with new strategies
to reach their target returns. One way they can do so is
by broadening their traditional portfolio allocations to
include alternative investments offering higher riskadjusted
returns, better diversification, and lower market
sensitivity. However, this does involve some specific
1 LOW-INTEREST-RATE ENVIRONMENT
This year, the challenges facing institutional
investors in achieving their target returns
remain as great as ever. In a low-interest-rate
environment which has now lasted more than
100 months, the task of dealing with diminishing
risk premiums has led to many innovative
solutions, but these reach their limits more and
more quickly. Many decision-makers are not
short of ideas or innovative talent, but they are
often prevented from realigning their investment
strategies – toward alternative investments,
for example – by investment guidelines which
no longer meet their requirements.
The need for alternative sources of return will
continue to grow, for the following reasons1:
1/Financial repression is not only continuing –
it has actually reached a new level in the last few
years. Yields on government bonds with high
credit ratings are still in negative territory. Hence
they no longer fulfil their traditional role as an
income-generating investment. The normalisation
of monetary policy expected in the coming years
must be priced in, and implies further downside
risks. Furthermore, government bonds will
probably cease to show a strong negative
correlation with risk-bearing asset classes.
2/The bullish trend of equity markets will
continue to be driven by a continuing loose
monetary policy, and a world economy expanding
broadly in line with its potential rate. But how
much upside potential do equities really have?
3/It is gradually becoming necessary to prepare
for increased volatility. High valuations, possible
normalisation of monetary policy by relevant
central banks, and heightened geopolitical risks
could soon lead to a correction for risk assets.
In this scenario, our advice is to look for
alternative investment strategies with a
conservative risk-return profile as a substitute
for bonds, supplement the equity allocation
with market-neutral strategies with low effective
exposure (beta), manage volatility, and
implement hedging strategies. Extending a
traditional portfolio allocation to include
alternative investments allows investors to
achieve a higher risk-adjusted return, better
diversification and potentially lower market
This is often easier said than done. In this article, I
would like to focus on the use of liquid alternative
"IN A LOW-INTEREST-RATE ENVIRONMENT WHICH HAS NOW LASTED
MORE THAN 100 MONTHS, THE TASK OF DEALING WITH DIMINISHING
RISK PREMIUMS HAS LED TO MANY INNOVATIVE SOLUTIONS, BUT
THESE REACH THEIR LIMITS MORE AND MORE QUICKLY."
2 LIQUID ALTERNATIVE INVESTMENT STRATEGIES
Now that there is such a wide range to choose
from, it is wise to invest in a diversified portfolio
made up of different alternative strategies. In
practice, this diversified portfolio often has two
objectives: a) to generate positive income over a
market cycle with low risk, and b) to make a
valuable contribution to the overall portfolio by
enhancing returns and diversification.
Depending on the risk budget, based on our inhouse
estimates, we believe a bandwidth of 1.5%
to 3.5% above EONIA to be a realistic target.
Starting with a typical institutional equity-bond
portfolio, and allocating 10% to a basket of liquid
alternative investments instead of bonds, can
increase portfolio return expectations by 0.1 to 0.3
percentage points (depending on the structure
of the absolute return portfolio) over the medium
3 SYSTEMATIC INVESTMENT PROCESS
The following investment philosophy has been
proven to achieve this goal:
Collect different alternative risk premiums
Focus on risk management
Aim for broad market neutrality vis-à-vis equity
and interest rate risks
Implementing this investment philosophy calls for
a systematic approach2:
1/ STRATEGY DEFINITION:
First, the investor should state his expectations as
to the desired risk-return profile realistically, and
define the permitted strategy spectrum, taking any
restrictions into account.
2/ MANAGER SELECTION:
The investor should identify managers who model
the alternative risk premiums effectively and in a
stable manner over time. These managers should
differ with regard to their strategy spectrum.
Qualitative analysis is particularly important when
selecting alternative strategies.
3/ PORTFOLIO CONSTRUCTION:
When creating an absolute return portfolio, in
addition to the primary aim of generating returns
while reducing overall risk, attention must also be
paid to avoiding cluster risks. Quantitative tools
such as forward-looking modelling, optimisation
and risk breakdown should be supplemented by
qualitative considerations such as predetermined,
built-in constraints to optimisation and scenario
Ongoing quantitative and qualitative monitoring
at investment level is important, in order to
compare performance with the expected riskreturn
profile of each strategy, to evaluate any
performance outliers, and to make any necessary
changes to the portfolio in good time.
A: LIQUID ALTERNATIVE (ABSOLUTE RETURN) STRATEGY SEGMENTS
Source: AllianzGI Global Solutions.
4 RISK PREMIUMS AND PERFORMANCE CHARACTERISTICS
To benefit from the whole range of alternative
strategies, investors need to be aware of the
different types, specific risk premiums and
performance characteristics of these strategies.
Strategies in the “relative value” and “event-driven”
segments often specialise in isolating alternative
risk premiums (e.g. volatility, merger arbitrage).
Directional market exposure (vis-à-vis equities or
bonds) is not typically a main driver of returns for
these strategies. “Macro strategies”, by contrast,
involve deliberate and dynamic exposure to
directional market influences. They seek to
profit from short and long-term trends or
macroeconomic developments. “Equity long/
short” strategies, on the other hand, are strongly
driven by stock selection with corresponding
equity market positions, but also seek directional
Our company’s analysis clearly shows that the
equity market-neutral, merger arbitrage and credit
long/short segments have the effect of reducing
risk in a portfolio context, while the global macro
and managed futures segments can perform the
role of generating returns.1
B: IMPLEMENTATION PROCESS FOR A LIQUID ALTERNATIVE STRATEGIES PORTFOLIO
Source: AllianzGI Global Solutions.
Investors can achieve attractive risk-adjusted returns at low risk with a diversified portfolio of liquid alternative strategies, thereby enhancing
returns and diversification in the overall portfolio.
Given the heterogeneous nature of the strategies on offer, an in-depth understanding of alternative risk premiums and intelligent portfolio
construction are important to achieving the desired results. An investment process in which the strategy definition, manager selection,
construction and monitoring are specifically tailored to liquid alternative strategies will also be advantageous.
Dr. Wolfgang Mader,
Head of Investment
& Risk Strategy,
Head of Institutional D/A/CH,
Allianz Global Investors
1) The statements contained herein may include statements of future expectations and other forward-looking statements
that are based on management's current views and assumptions and involve known and unknown risks and uncertainties that could cause
actual results, performance or events to differ materially from those expressed or implied in such statements. We assume no obligation to
update any forward-looking statement.
2) A performance of the strategy is not guaranteed and losses remain possible.
Investing involves risk. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on management's current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. We assume no obligation to update any forward-looking statement. The value of an investment and the income from it may fall as well as rise and investors may not get back the full amount invested. There is no guarantee that the strategy will succeed and losses cannot be ruled out. Investors may not get back the full amount invested.
The volatility of fund unit prices may be increased or even strongly increased. Past performance is not a reliable indicator of future results. If the currency in which the past performance is displayed differs from the currency of the country in which the investor resides, then the investor should be aware that due to the exchange rate fluctuations the performance shown may be higher or lower if converted into the investor’s local currency.
This is for information only and not to be construed as a solicitation or an invitation to make an offer, to conclude a contract, or to buy or sell any securities. The products or securities described herein may not be available for sale in all jurisdictions or to certain categories of investors. This is for distribution only as permitted by applicable law and in particular not available to residents and/or nationals of the USA. The investment opportunities described herein do not take into account the specific investment objectives, financial situation, knowledge, experience or particular needs of any particular person and are not guaranteed. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer and/or its affiliated companies at the time of publication. The data used is derived from various sources, and assumed to be correct and reliable, but it has not been independently verified; its accuracy or completeness is not guaranteed and no liability is assumed for any direct or consequential losses arising from its use, unless caused by gross negligence or willful misconduct. The conditions of any underlying offer or contract that may have been, or will be, made or concluded, shall prevail.
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This is a marketing communication issued by Allianz Global Investors GmbH, www.allianzgi.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42–44, 60323 Frankfurt/M, registered with the local court Frankfurt/M under HRB 9340, authorized by Bundesanstalt für Finanzdienstleistungsaufsicht (www.bafin.de). This report does not satisfy all legal requirements on the guarantee of impartiality in investment recommendations and investment strategy recommendations and is not subject to any trade restrictions prior to the publication of such recommendations. The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted.
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