In a prolonged bull market environment where pullbacks are a greater concern, investors can consider ETFs that track liquid alternative investment strategies to build better portfolios and to mitigate downside exposure in case of sudden risk-off events.
On the recent webcast, Preparing for Down MarketConditions with Alternative Strategies, Salvatore Bruno, Chief Investment Officer and Managing Director at IndexIQ, outlined a number of worrying signs that investors are facing today. For example equities have risen substantially over the past 10 years. Rates are slightly higher than historic lows. Currencies have been range-bound since 2014, after a run-up in the US Dollar. Valuation metrics are relatively high to historic averages. Furthermore, we still have to digest potential tariff implications and rising Fed rates.
“Can the Financial Crisis happen again? Sure, but will the same risks come into play in the same order? Likely not. This is why a mix of non-traditional risks is an important piece of diversification,” Bruno said.
For example, Bruno pointed to hedge fund-esque strategies like long-short and event-driven, among others, as a way for investors to benefit from stress period persistence and risk diversification.
In a highly correlated global market, investors should consider strategies that offer lower correlations or do not follow the movements of traditional stocks and bonds. The MSCI EAFE Index exhibited a 0.92 correlation to the S&P 500 from 2007 to 2009, compared to a 0.47 correlation back in 1980 to 1990 – a 1 reading corresponds with a perfect, lock-step correlation.
“Intertwined global financial markets result in greater correlations across markets,” Bruno said.
In comparison, looking at Hedge Fund Research Indices (HFRI), a fund weighted index exhibited a 0.76 correlation to the S&P 500, a market neutral index showed a 0.27 correlation and a merger arbitrage index had a 0.53 correlation.