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By Cleo Chang - November 14, 2018
Volatility has made a comeback in the equity markets, and that’s actually a good thing for active managers. It gives us an opportunity to make buy, sell and hold decisions based on true fundamentals. And for managers of alternative investments (alts), the return of volatility also gives us the chance to benefit from long positions, but also against companies and sectors that we look at skeptically. In fact, we’re already seeing alts managers posting more competitive performance compared to the traditional long-only strategies on a risk-adjusted basis.
Based on discussions we’re having with investors, I think we’re starting to see a shift in mind set: many are looking for more hedges right now, which is leading to asset flows into long-short strategies. In the course of this current 10-year bull market, we haven’t heard “hedge” getting thrown around much as an investing tactic.
In my latest quarterly video, I dive into all of these topics, as well as the hotly debated yield curve—and what an inversion might (or might not) tell us about the economy and the potential for a recession.
I think the Fed obviously is doing a very nice job watching the economy, making sure that they try to tighten monetary policy at the right time without putting damaging pressure on the economy. When interest rates are at zero, essentially, it's free for people to borrow money to make investments into risky assets. So that, I think, was partially responsible for the absence of volatility in a way.
So, as you start to see interest rates to go up, there is actually a price for borrowing money to invest in risky assets. I think it's very natural to see volatility return into the marketplace. I think that the investors haven't seen this level of volatility for some time, so I think people are getting used to it. I think the volatility is still very muted, compared to historical levels, but it does set a nice stage for active management.
This is where, I think, active management is really set up to excel—where you can make active decisions based on fundamental information, other market trends or things that you think will out-perform other parts of the market. And I think for alternative managers, especially, while we are typically allowed to not only have long positions, but have short positions on things that we're less favorable on, that widens the the universe a bit more for alternative managers, and I think the return volatility will be really beneficial.
As volatility comes back to the market, one of the things we naturally expect is broader dispersion of manager performance, but overall we're seeing alternative managers putting up more competitive performance relative to the equity market and the fixed-income market. So I think, in that sense, we're seeing the volatility start to benefit alternative managers in ways we haven't seen in the last couple of years.
We're hearing the word “hedge” a lot more often than we used to a year or two, so I think there is something changing in the mindset of investors out there, and long-short equity naturally serves as one of the strategies that does provide investors with some level of hedging. It doesn't mean it will outperform, but if there is hedge positions within the portfolio.
I think from that perspective, we're also seeing flows being attracted to long-short equity categories. I think there is also the sentiment shift that we're seeing, and we're also seeing the asset flows following that sentiment.
We've been talking about the flatness of the yield curve for some quarters now. I think we first pointed out to investors the flatness of the yield curve at the beginning of the year. And since then, it's continued to flatten. I want to make sure that everyone understands a flat yield curve doesn't always lead to inversion, and inversion of the yield curve doesn't always lead to a recession. There is just the likelihood of this being a leading indicator.
We are not anticipating a recession in the near horizon, but we do think a flat yield curve does put pressure on certain businesses in a way that a steeper yield curve doesn't. The way we're managing against that is really to manage the portfolio on a shorter duration—to continue to benefit from the rising short end of the yield curve. We’re not so worried about hedging the long end of the curve because it's been relatively stable. We're trying to take advantage of the rising rates on the short end as a primary goal to generate more income for investors.
As volatility re-emerges in the marketplace, we're actually not seeing the typical diversions between equity performance and bond performance that we typically would expect to see. However, we are seeing the divergence coming from alternative investments, compared to equity returns and bond returns. So, in this environment, we actually think it's a conducive environment for alternatives to serve as a diversifier for investors' portfolios, holding stocks and bonds.
Volatility has made a comeback in equity markets. This quarter, Sr. VP & Head of Investment Solutions Cleo Chang explains how that benefits investors in the alternatives space.
November 14, 2018
The stock market took investors on a rollercoaster ride over the past week. What did we learn?
October 12, 2018
Fund(s) shown may take short positions. A short position arises when the fund sells stock that it does not own but was borrowed in anticipation that the market price of the stock will decline. If the market price declines, the fund can replace the borrowed stock at a lower price and capture the value represented by the difference between the higher sale price and the lower replacement price. Conversely, if the price of the stock goes up after the fund borrows the stock, the fund will lose money because it will have to pay more to replace the borrowed stock than it received when it sold the stock short. Any loss will be increased by the amount of compensation, interest or dividends, and transaction costs the fund must pay to the lender of the borrowed security. In addition, because the fund's loss on a short sale stems from increases in the value of the stock sold short, the extent of such loss, like the price of the stock sold short, is theoretically unlimited. By contrast, a fund's loss on a long position arises from decreases in the value of the stock and therefore is limited by the fact that a stock's value cannot drop below zero. In addition, the fund may not be able to close out a short position at a particular time or price advantageous to the fund and there is some risk the lender of the stock sold short will terminate the loan at an inopportune time.
A long position is the opposite of a short position. A long position is the buying of a security such as a stock with the expectation that it rise in value.
Alternative mutual funds that hold a variety of non-traditional investments also often employ more complex trading strategies than traditional mutual funds. Each of these different alternative asset classes and investment strategies have unique risks making them more suitable for investors with an above average tolerance for risk.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.