Active Thinking

At GAM Investments’ latest Active Thinking Forum, some of our brightest investment minds discussed the advantages of liquid alternative diversifiers and also why an unusual year in emerging market sovereign credit may present a buying opportunity.

20 September 2021

Rosa Wunner – Systematic Investing in Liquid Alternative Diversifiers

Alternatives can be defined as any asset class other than stocks, bonds or cash. While alternatives such as real estate investments, private equity investments, art and antiques have a rather illiquid profile, ‘liquid alternatives’ operate in the world’s most liquid markets. This allows us to create portfolios that can be reactive and dynamically adapt to market moves. This inherent liquidity can also be passed on to investors – an advantage for those investors who hold mostly illiquid asset classes in their portfolio or require additional liquidity.

‘Liquid alternatives’ focus on instruments such as futures, forwards and other derivatives. An investment in liquid alternatives can provide exposure to a large range of diversifying asset classes: the fund can gain exposure to equity markets via equity index futures, access the bond markets with bond futures, trade a broad set of commodity futures, and access G10 and emerging market currencies via forwards. Liquid alternatives – especially when traded systematically – are able to invest in a large set of global macro markets, all of which serve as diversifiers in a portfolio and provide uncorrelated sources of return.

A systematic liquid alternatives portfolio offers the advantage of trading without directional bias – holding both long and short positions in the multiple assets and, importantly, can therefore provide investors with ‘convexity’ – allowing the portfolio to gain in both bull and bear market conditions. This results in inherently low correlation to traditional assets and can be a particularly useful addition to a bond or equity-heavy discretionary investment portfolio. By design, a systematic liquid alternatives investment affords the ability to access returns regardless of the prevailing market environment and can therefore help maximise the opportunity set.

Our systematic approach to investing – employing proprietary algorithms for portfolio construction, risk management and execution – is rules-based, research-focused and repeatable. Systematic investing is also less prone to a number of biases, such as human, behavioural, recency or confirmation bias. Moreover, our particular systematic investment approach for liquid alternatives is designed to offer maximum diversification, employing not only multiple diversifying and liquid assets, but carrying this approach through to the investment methodology by combining multiple trend-following strategies with other, uncorrelated models and return drivers.

In summary, liquid alternative diversifiers can prove a valuable addition to an investor’s portfolio due to a) their natural liquidity profile, and b) their inherent diversifying qualities. These benefits are further enhanced by the sophisticated, proprietary investment methodology and implementation we have developed.

Richard Briggs – Emerging Market Sovereign Credit

We believe outperformance in emerging market (EM) sovereign debt is generated by a combination of macro analysis and credit selection, which essentially means making the right macro call (such as exposures to high yield (HY) or investment grade) and choosing the right credits, particularly within EM HY.

Credit spreads within sovereign credit this year have been unusually stable – moving only across a 40 bps range – and year-to-date (as at mid-September) spreads are only around 7 bps tighter. So, evidently there just have not been large returns from a move at the macro level in credit this year. In our view, the macro outlook from here is still very constructive and EM HY, and spread duration within that, could be set to perform well going forward.

This year, the key differentiation within sovereign credit returns has been credit selection given the stability of the macro environment. EM HY has outperformed this year, but that broadly reflects a few issuers such as Zambia, Sri Lanka, Ecuador, Angola and a few others. For the most part HY issuers have seen spreads widen or are only marginally tighter so far this year. This has been particularly true for big issuers like Egypt or Ghana, for example.

When making credit selections we believe decisions need to continue to be alert to idiosyncratic opportunities, particularly within EM HY where we believe that there continues to be exciting opportunities. Key examples include Ecuador, where supportive oil prices, limited near-term debt repayments post restructuring and a reform-driven administration should support spread tightening. Another example is Ukraine where both fiscal and external metrics have been remarkably robust when accounting for the impact of the pandemic. Tunisia is another country we like, despite political instability more recently which has driven spreads wider and given reserves which remain reasonably high relative to repayments. Thus, we believe the country should be able to continue to make repayments, even if IMF support is delayed given political disruption.