Investors will have to be more tactical opportunistic in their approach and willing to tilt portfolios from beta to alpha to ensure survival in a low-return environment, according to Mercer.
According to the consulting firm’s paper on investment themes, 2016 presents an “environment of heightened uncertainty and fatter tails,” from events such as China’s slowdown and central banks’ monetary policies.
“Alpha is challenging to find and is not a single homogeneous return source that may be captured by appointing active managers.”“With relatively few markets that can be described as ‘cheap,’ investors will be well-served by remaining patient but ready and able to act opportunistically when markets move to extremes,” said Deb Clarke, Mercer’s global head of investment research.
To add value amid the current unattractive risk/return tradeoffs of traditional beta, Mercer argued investors allocate more to active management—but only if they are able to tolerate fees and are skilled in manager selection.
“It is important to recognize that alpha is challenging to find and is not a single homogeneous return source that may be captured by appointing one or more active managers,” the report said.
Mercer also argued investors should take advantage of reduced liquidity in traditionally liquid markets—like the US treasury and German bund markets—that could lead to periodic increases in price volatility in “gap moves”.
Contrarian investors have an even better advantage to capture opportunities in such periods of market stress, the paper said, through opportunistic and dynamic strategies.
Furthermore, a maturing credit cycle also calls investors to take a “more cautious stance,” Mercer said.
For those that are able to adjust market exposures dynamically over time, the consultant suggested tilting portfolios towards less volatile strategies such as low volatility equity, high-quality credit, and absolute-return fixed income.
Investors could also take advantage of high default rates and opportunities in distressed debt.
“Although this phase of the cycle could yet be a few years away, investors wishing to capitalize on such an opportunity may want to start considering the asset class and possible implementation approaches during 2016,” Mercer advised.