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How liquid alternatives could protect your portfolio during market downturns

As investors seek ways to protect themselves from drawdown risk, could liquid alternatives be the answer?

18/12/2019
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In the ten years since the global financial crisis, financial markets have flourished in an environment of loose monetary policy.

Although equity markets have been reaching new highs, market conditions have remained challenging for those seeking ways to generate alpha.

As geopolitical tensions rise and monetary policy begins to tighten, global markets are starting to stagnate. With that, a new wave of challenges are being presented to investors.

One of these challenges is drawdown risk. It is becoming a significant concern to those who seek to manage the risk/ return profile of their portfolios.

Drawdown risk, defined here as the largest peak-to-valley loss over a given period of time, has historically been a challenge to most investors. As assets become more correlated with each other, investors find it ever more difficult to find assets that could adequately offer the appropriate cushion of protection against market downturns.

The chart below highlights the  past consequences of these market downturns. It shows the largest drawdowns in both the S&P 500 and the HFRU Hedge Fund Composite index (chain-linked to HFRI) since 2000. This index is designed to be representative of the overall composition of the UCITS-Compliant alternative investment strategy universe.

2019-Dec_Liquid-alts

This chart captures two economic cycles and subsequently two periods of major drawdown – the dotcom bubble burst and the global financial crisis.

During both market downturns, both the frequency and magnitude of drawdowns have been significantly less for the HFRU index, when compared with the S&P. During the bursting of the dotcom bubble , the S&P’s peak drawdown reached -45%, whilst the HFRI’s peak drawdown was -6%.

Similarly, during the global financial crisis, the HFRI’s peak drawdown was only -7.2%, whilst the S&P peaked at -51%. Taking this into consideration, it becomes apparent that hedge funds can provide an adequate cushion against drawdown risk during market downturns, potentially proving to be an important asset for providing protection to investor portfolios.

Liquid alternatives can provide access to hedge fund strategies through a regulated product structure. By utilising liquid alternatives, an investor could find themselves in a better position to navigate through challenging periods and, therefore, strive towards achieving the appropriate risk/ return profile that suits their needs.  

You can find out more about Schroders liquid alternatives capabilities here.

 

 

 

 

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