Environics survey shows funds provide different risk mitigation, diversification, and returns
It’s been three years since the Canadian Securities Administrators introduced alternative funds to Canada, so Picton Mahoney recently did an Environics survey with advisors to check what they’re using and why to help them improve their portfolio outcomes.
“We looked at all of the prospectus-based alternative strategies in Canada that had more than a three-year track record, and we assessed these strategies based on their ability to deliver the outcomes that investors are seeking,” Robert Wilson, head of portfolio construction consultation services at Picton Mahoney Asset Management told Wealth Professional.
“We surveyed advisors to understand the key reasons why they’re allocating, or looking at, alternatives for their portfolios, and the two main reasons were portfolio risk and diversification. That makes a lot of sense for us because, if you can focus on improving those outcomes, you’re going to reduce your likelihood of a significant drawdown, which means that investors can avoid making difficult decisions like having to delay their retirement or take a high level of risk to recoup a loss or cut back on their lifestyle.”
Wilson noted that advisors have traditionally turned to fixed income to deliver those incomes, but they’re not delivering for portfolios now. So, Picton developed custom scorecards that rated risk mitigation, diversification, and quality returns, then assessed the strategies across multiple methods to establish an overall score and ranked their overall score with a weighted average.
It discovered that the average alternative funds would provide the benefits across those objectives, but there were broad categories of different asset classes and strategies, plus a wide dispersion of outcomes over the past three years. So, selection is important.
“What we found is that, within each category, the strategies that were taking relatively little risk, and so were more absolute return or event driven, tended to have the highest scores when it came to risk mitigation and diversification. That also meant the category that had the highest overall score was the alternative market neutral category.”
Picton Mahoney looked at five categories and found that, within each category, the strategies that were more apt to return are event driven. In the alternative credit category and alternative equity categories, the market neutral category had the highest average score.
What surprised him was “there’s a difference between the categories that are capturing the highest asset flows and the categories that have the highest average scores on risk mitigation and diversification. So, the lowest scoring categories were alternative credit and alternative equity, but those were also the categories over the past year that have had the highest net sales.
“So, we dug a little deeper and what we found is, because of the wide dispersion within those categories, there are some fantastic strategies that focus on diversification and stability. So, it points to the need to look under the hood – unlike traditional assets, where you can start by filtering by category.”
Given that, Picton Mahoney encouraged advisors to create customer peer groups, and filter based on high-level characteristics that align strategies with their goals.
“Before you have to get into manager selection or evaluating strategy, invest the time to establish a clear objective for why you’re making the allocation. If you can nail down the purpose of the alternative program, you’re going to have a much better time of identifying strategies that are the most beneficial to you,” he said, noting it’s also wise for advisors get support from alternative asset managers to help them with the selection process since different products deliver different results on risk mitigation, diversification, or returns.
“The challenge of those three goals is somewhat oppositional,” he said. “There’s a trade-off between them. So, if you want more of one, you might end up getting flak from another.”
Wilson said the fact that the highest net loads have gone into the alternative credit and alternative equity categories suggests advisors want to modify return – even though some of the top selling strategies in those categories have been more focused on risk mitigation. But he said advisors now are putting absolute return strategies front and centre because, “in the current market environment, they’re realizing that there can be a high correlation between directional strategies. So, there’s a need to have a layer within the portfolio that is more dependent on manager skill and less dependent on changes in the level of direction for markets.”
Wilson urged advisors to take three steps to ensure their success.
First, develop a goal-based framework to narrow their investment universe and look at the strategies across multiple categories, so they don’t miss any strategies or managers who could help them reach their goals.
Second, develop a quantitative scorecard to evaluate funds.
“This approach can help save you time, both in terms of formulating a shortlist of strategies to perform due diligence on, but also in terms of improving your ability manage, or monitor, your existing managers that are within your portfolio and save yourself time in the process,” he said.
Finally, decide what metrics to use to evaluate the strategy to ensure they align with their goals to ensure that the client goal, allocation, and manager selection are all in alignment. “That really is going to go a long way to help you get a more positive outcome,” he said.
Finally, they should educate their clients about what they’re doing, and how, to achieve their goals in this new, and growing, field.