Why alternatives are poised to play greater role in portfolios

Global chief strategist backs swoosh-shaped recovery and says investors need to think harder about how they diversify

Why alternatives are poised to play greater role in portfolios

Prepare for a swoosh-shaped recovery with alternatives playing a greater role in investors’ portfolios, according to HSBC’s global chief strategist.

Joseph Little's investment outlook also highlighted China and Asia as being the best positioned economies and that the accelerated take-up of technology and sustainability trends gives rise to selective opportunities.

He said the big question for investors is how fast the macro system can restart. Once the virus is manageable, he believes that, in principle, the system should be able to recover quickly from this self-enforced closure, although it’s reasonable to expect setbacks and a full recovery may take time.

So what should investors do to navigate through this period? Little believes the current crisis has accentuated the already steep trade-off between risk and returns, and that current prices suggest sub-inflation returns for core government bonds over the medium term, while riskier asset classes are discounting much higher rewards.

“With government bonds not being attractive from a valuation perspective and their hedging properties becoming increasingly limited as interest rates approach zero, investors need to think harder about how they diversify,” he added.

“We currently favour global equities and high-yield bonds on a strategic, long-term basis. In equities, while the crisis represents a challenge for the global economy and profit cycle, lower prices this year have increased our measure of prospective returns. We think that investors willing to absorb near-term volatility will be compensated over the next couple of years. Lower developed market government bond yields have also increased the relative attractiveness of equities over bonds, while substantial policy easing has reduced downside tail risks for equities.”

HSBC prefers Asian credits to developed markets ones as they continue to offer higher spreads for similar credit risk, and the region is well positioned for recovery. Alternatives – liquid and illiquid – should start playing a greater role in portfolios too. 

He said: “We particularly favour strategies that offer low correlation to traditional asset classes and downside protection from equity downside risks. Strategies like style premia, trend following, equity factors such as ‘quality’, and some liquid hedge fund strategies can prove useful in this environment. We also like private equity as it can offer an opportunity for return enhancement. However, illiquidity and leverage mean this investment is not adequate for all types of investors.”