In advocating for a ‘three-stream portfolio,’ Robert Wilson outlines why this market environment suits some alternative strategies
Robert Wilson takes the view that conventional public market strategies don’t offer the right kinds of diversification now. The Head of Innovation and Portfolio Strategist at PICTON Investments in Toronto believes we’ve now seen enough instances of inflation-induced positive correlation between stocks and bonds that alternative forms of diversification should be sought. As investors look to protect equity gains from this bull market, Wilson and his firm are advocating for a shift to a “three-stream portfolio” that adds a sleeve of alternatives as a meaningful diversifier.
Wilson outlined how he believes alternatives can work as a diversifier in today’s macro conditions. He highlighted specific areas within the vast universe of alts, especially alternative management strategies for public securities which can offer diversification without significant liquidity compromises. He argued that the current public market environment, especially in equities, demands new forms of diversification as narrative risk concentrates returns around a single theme.
“Proper risk management today means looking beyond the traditional risk framework and thinking about thematic or narrative risk. If you're building an equity portfolio today, your tech analyst comes to you and they have some company that they like because they're going to benefit from what's going on with AI. Your industrials analyst has some company that's going to be doing the data center build out. Your commodities analyst has got some miners going to benefit from these nuclear plants that are coming in. The same thread is pulling all these trades,” Wilson says. “The way you need to think about risk management, it's not how many positions you have, is how many effective bets are in your portfolio. And I think a lot of investors would be surprised right now with the narrative risk in the market with AI driving things, they have way less effective bets than they think.”
Alternative strategies for liquid assets
Alts as a third stream of modern portfolios opens up a truly vast investable universe for advisors to consider. However, Wilson argues that the contemporary market environment and the individual needs of retail investor clients should point advisors towards certain specific alternatives sectors. He calls out commodity exposures as a useful inflation hedge as well as market neutral and absolute return strategies to mute sensitivity to equity markets and GDP growth.
The goal in the latter category is to diversify risk away from equity themes while outperforming cash. That should result in a portfolio where returns remain additive but risks are not. Market neutral and absolute return strategies, Wilson notes, use alternative mechanisms like stock shorting to either amplify market return or mitigate market risk, offering a differentiated return stream from long equity positions.
Returns in those strategies, Wilson notes, tend to be driven more by manager skill than by broader market performance. They are also largely derived from equities, making them taxable as capital gains rather than interest income. Wilson emphasizes how useful that can be for higher net worth investors with low risk tolerances, who need income but prioritize tax-efficiency.
One of the most important advantages of strategies like market neutral or absolute return is that they tend to come with the same liquidity as most public securities. For retail investors, who don’t have the capacity for illiquidity required by some private asset and real estate investments, that can be a significant advantage.
Assessing management quality
The rise of these kinds of highly active, manager-driven strategies fits into how Wilson sees investment dollars flowing. Over the past 20 years, he says, a significant net flow of investor assets has moved away from actively managed long strategies into two buckets: passive funds and alternatives. The alternatives side, he says, offers a ‘barbell’ contrast to low-cost passive funds that can deliver long exposures.
As advisors consider the active alts side of the portfolio, however, Wilson acknowledges that there is a high degree of education and information required. That begins with education about the strategies themselves, and then an education about how to identify them. He argues that labels can present a trap for investors. Just because something isn’t a stock or bond fund, that doesn’t make it a good diversifier. Wilson gives the example of real estate, which represents interest rate and economic growth risk: the same primary risk drivers as equities.
Assessing management quality is essential to success in such an active area. Wilson says that advisors should dissect returns from the strategy before them to find out how much was derived from skill and how much was derived from the investment style. If style was the primary driver, then an advisor may be paying active prices for passive performance. Once they have that understanding of a strategy, Wilson says that advisors can explain funds to clients across four key areas.
“Performance, risk management, diversification benefit, and tax benefit,” Wilson says. “That last one is critically important. We have a bit of an availability bias. Pre-tax returns are what get quoted to us. But after-tax returns are what clients can actually spend, a lot of alternative strategies can produce meaningful benefits, in terms of improving the post tax return. I would just say you want to focus almost like a balanced scorecard across performance, risk management diversification and tax efficiency in terms of communicating with clients.”
