Adding an alternative beta strategy for diversification

Funds Management

by Clive Tompkins

MLC Head of Alternative Strategies, Gareth Abley talks about the Alternative Beta strategy and how, when well executed, it can deliver returns of roughly cash plus three to five per cent, net of all fees, with a very low correlation to equities and bonds.

Hi. I’m Gareth Abley, I am the Head of Alternative Strategies for MLC. We look after about $4 billion of client assets and our goal in life is to generate attractive, uncorrelated returns for our clients.

In some ways it’s easier to start by explaining what it isn’t, because the word Beta often is used to describe a long only exposure to an index, like the S&P 500 or the Barclays Global Aggregate index in bonds, which is very cheap and easy to implement. Alternative Beta is not that. So Alternative Beta in reality is exposure to relatively well-known, systematically implemented hedge fund strategies. The key twist is that they’re now available much more cost effectively and transparently, for investors than they used to be.

So a well-executed Alternative Beta strategy, and the key there is well executed, we think can deliver returns of roughly cash plus three to cash plus five per cent, net of all fees. And importantly, it can do so with a very low correlation to equities and bonds. And we think that’s particularly important generally for investors, but particularly given where we are in the economic cycle, where equities are nine years into a bull market. And bonds clearly have low yields that are susceptible to rising, which would hurt investors in bonds.

Probably the most important is that there are very different sub strategies that exist within the umbrella of Alternative Beta. So one sub strategy would be equity market neutral exposure to factors like value, quality, momentum. So this would be a portfolio of say 2,000 stocks that you’re long, 2,000 stocks that you’re short, your net exposure to the market is basically zero. So it has very reliably stable low correlation to equities.

Other categories such as trend following and other macro categories with Alternative Beta, can take directional exposure to all asset classes, one of which is equity. So even though they’re often marketed as having a negative or zero correlation to equities, at certain points in the cycle e.g. March, February 2018, they can be long equities when equities go down. So you have to have a very careful understanding as to the nature of those strategies, and the proportion allocated to those strategies, in order to understand the broader risk return characteristics that you have within your Alternative Beta portfolio.

The second thing that is really important and probably less well understood is that two Alternative Beta managers, who are very well credentialed implementing very similar strategies, can deliver very divergent performance. So again, a big difference versus Beta within the equity space, where two index trackers of the S&P 500 might deviate from each other by 20 basis points, over a year. Within the Alternative Beta space, we have seen and expect to continue to see managers deviating from each other, by 15 per cent per annum plus a year. So manager selection becomes hugely important.

And the third is fee efficiency. So we think there are quite subtle but important ways that investors need to think about the value for money, they get from their Alternative Beta strategy or strategies.

We think its always important investors look for ways to diversify their portfolios. We also think its very important that investors are sceptical in how they do that. There are no free lunches in investing. Having done significant research in this area, wethink that a well-executed Alternative Beta strategy, and the key there isto executing well, can add significant value and diversification to an investor’s portfolio.