Investment advisers are increasing allocations to strategies with lower correlation to traditional asset classes as they position client assets for potentially volatile market conditions ahead, according to the latest quarterly Natixis Portfolio Clarity US Trends Report.
The quarterly review of advisers’ moderate-risk model portfolios by Natixis in Q3 found allocations to a more diverse mix of investment strategies, including increased use of strategies with lower correlation to industry benchmarks and a shift to alternative investments that prioritise risk mitigation over return enhancement.
By actively increasing allocations to less-correlated assets, the diversification benefit to adviser portfolios, which measures the percentage of risk diversified away by lower correlations, rose to an average of 19.2 per cent in the third quarter.
The use of strategic beta strategies, indexes based on factors other than market capitalisation, has doubled since 2013, with 52 per cent of advisers using them in their moderate-risk portfolios. The average portfolio had 9.8 per cent of its assets in strategic beta strategies at the end of the third quarter, accounting for 45 per cent of passive portfolio allocations in the third quarter as advisers sought differentiated sources of returns from factor-driven products.
Managed futures was the most popular alternative investment strategy, accounting for more than one-third of allocations to alternatives, and the use of option-writing strategies also increased while exposure to multi-alternatives and long/short equity strategies declined, reflecting a larger trend toward alternatives for risk-reducing benefits.
Portfolios with 10 per cent or more allocated to alternatives continued to deliver better risk-adjusted returns the majority of the time than those with no alternative allocation.
“Financial advisers and institutions today have a wide range of options to help increase diversification, and it’s important to systematically leverage these tools to tailor each investor’s portfolio to their unique goals and risk tolerance,” says John Hailer, CEO of Natixis Global Asset Management for the Americas and Asia and head of global distribution.
The average moderate-risk model portfolios analysed by Natixis gained 3.24 per cent in the third quarter, compared to 0.46 per cent for the Bloomberg Barclays US Aggregate Bond Index and 3.85 per cent for the S&P 500. Year-over-year allocation trends demonstrated a gradual rebalancing of moderate-risk model portfolios, which continue to favour US equities.
Despite the trend toward diversified holdings, exposure to US equities soared to 80 per cent of equity allocations, the highest level in the history of the program. That hindered performance during the quarter as investors missed a rally in global and emerging market equities.
The average moderate-risk portfolio allocated 53 per cent of assets to stocks and 30 per cent to bonds, which is unchanged from the second quarter.
Though equities accounted for only 53 per cent of portfolio holdings, they represented 92 per cent of overall portfolio risk, up from 86 per cent in 2013, the highest proportion of risk since evaluation of this data began in 2013.
“After years of artificially low interest rates distorting global markets and suppressing volatility, investors are now concerned about potential shocks reverberating through the financial system due to increasing political, economic or social risks,” says Marina Gross, executive vice president of Natixis’ portfolio research and consulting group. “Our research shows their efforts to diversify will serve investors well when volatility returns to the market.”
The average overall expense for portfolios reviewed by Natixis has declined to 69 basis points in the third quarter from 83 basis points in 2013. For the first time this quarter, Natixis compared portfolio performance by expense ratios and found that higher expense portfolios outperformed lower expense portfolios 60 per cent of the time over the past three-year period.
