Alternative Investments Seek to Ease Volatility’s Sting

Why alternative investing strategies are gaining increasing traction with investors.

Mike Dieschbourg, managing director for the Alternatives/Managed Risk Group at Federated Investors, talks about why alternative investing strategies are gaining increasing traction with investors. When the worst financial crisis in decades hit in 2008, even a diversified “60/40” portfolio lost as much as 23.69%1 of its value. It was a wake-up call to investors who discovered that diversifying their portfolios between stocks and bonds didn’t deliver the protection they anticipated. Although correlations were already on the rise leading up to the broad sell-off, the severe market turmoil caused most asset classes to become even more correlated. There’s been plenty of volatility since, and given current geopolitical uncertainties and the potential for other systemic risks such as a global recession, we believe there is no reason to think that a traditional diversification approach can spare investors in the future. Averages don’t lie but they can mislead Indeed, while long-term averages show stocks have generally delivered positive returns and provided investors with the greatest opportunity for gains over long periods of time, they fail to reveal the large variations within any year and from one year to another. On a daily basis, down markets may occur as often as up markets (see chart). The problem is it can be hard to make up for lost ground, as the rate of return required to recoup a loss is always greater than the loss itself. For example, if you start with $1,000,000 and lose 20%, you are left with $800,000. To determine what percentage gain it would take to recover your loss, divide your starting capital of $1,000,000 by your ending amount of $800,000. You get 1.25—meaning you must make 25% on your $800,000 just to get back to your starting amount of $1,000,000. In other words, it can take years to recover from downside volatility, as many investors discovered in the last 20 years, when the S&P 500 experienced two severe drops—49% early on during the dot-com collapse, and 57% during the global financial crisis—that devastated many portfolios. With portfolios so frequently subject to the damaging impact of down markets, there’s good reason to consider an allocation to alternative investments that have the potential to reduce volatility and lessen downside risk. Federated’s approach to alternative investing Although the concept of alternative products as a “fourth asset class” is relatively new to investors, Federated Investors has had a focus on such products for more than 15 years. Active risk management and risk-versus-reward analysis are the guiding principles of Federated’s alternative investment approach. This approach involves an investment discipline that includes bottom-up fundamental security and industry research paired with top-down credit, global macro insights, market liquidity and policymaking analysis, and the daily use of downside risk management techniques. Federated alternative strategies are subject to stringent regulatory, fiduciary and disclosure requirements, offering investors transparently managed, liquid and cost-effective access to a wide range of strategies designed to limit downside risk while seeking competitive performance.
  1 The max drawdown in 2008 consisting of a portfolio combination of 60% S&P 500 and 40% Barclays U.S. Aggregate Bond Index. This example is for illustrative purposes and is not representative of any specific investment. Actual investments cannot be made in an index. Past performance is no guarantee of future results. Alternative investing, including use of futures, options and short positions, may involve risks different from or possibly greater than the risks associated with investing directly in securities and other traditional investments.