Liquid diversifiers: Why now?

Few would argue that the market regime has changed markedly from the days of ultra-low interest rates, further fuelled by waves of quantitative easing¹ that lifted all boats. The Covid-19 pandemic led to an increase in volatility, less price stability and inflation moving structurally higher. Moreover, the traditional negative correlation between bonds and equities has broken down over the last few years, creating a need to update the investment toolkit, diversifying away from traditional equity and bond exposure to create a more resilient return stream.

Today’s market backdrop presents a number of risks, many of which are structural in nature as a result of the end to the ‘easy money’ era, and there will be a need to have a keen awareness of considerations such as ready liquidity, market and individual stock valuations, and concentration risks.

Navigating risks and opportunities in a changing global landscape

Recent developments in artificial intelligence, where on a number of occasions in recent months we witnessed the posterchild Nvidia lose a significant portion of its value, sometimes in a single day,² have placed the spotlight on idiosyncratic risk. The US equity market now represents over 65% of the world index, and the largest ten companies now account for 23% of this.³ This level of concentration could cause havoc should elevated expectations start to unravel. However, this represents fertile ground for discerning investors as the level of implied risk also represents opportunity.

The macroeconomic risk inherent in the backdrop challenges those structures and businesses unaccustomed to operating in a higher interest-rate environment. There is a need to distinguish the potential winners from the losers: more fragile companies are likely to struggle, while nimble, creditworthy entities should thrive. This applies across the asset-class spectrum, from equities to fixed income to alternatives, and managers need to possess skill to select the best outcomes.

Another observable shift is the formation of spheres of influence in the world, evidenced by the geopolitical tensions which have become increasingly visible with tangible consequences, notably the outbreak of war in the Middle East and the Russia/Ukraine conflict. The return of President Trump to the White House adds an additional source of uncertainty as world leaders wrestle for control of a broad agenda. A changing world order will have major implications for capital and how we choose to invest. Indeed, it can be viewed as the reshaping of the capital system which, while daunting when viewed through one lens, can also be viewed as an opportunity for growth and innovation.

Harnessing liquid and diversifying strategies in a volatile market

These forces should represent an environment in which strategies that are both liquid and diversifying can be invaluable. Rather than adopting a ‘buy and hold’ approach, we think there will be a need to be nimble and dynamic, using as wide a toolkit as possible to seek to capture diversified sources of return. Currency will also be an important factor; a weakening of the US dollar, for example, could have global repercussions and misalignment can create opportunities.

Rather than adopting a ‘buy and hold’ approach, we think there will be a need to be nimble and dynamic, using as wide a toolkit as possible to seek to capture diversified sources of return.

Moreover, approaches such as relative-value strategies (which seek to take advantage of price differentials between related financial instruments) can benefit from greater dispersion and market volatility and have the potential to perform well in this environment. Likewise, tail-risk hedging approaches (strategies seeking to mitigate exposure to downside risk), which acknowledge the shortcomings of traditional multi-asset diversifiers such as fixed income, may provide a more reliable form of protection in the context of a more skittish, volatile backdrop.

Collaboration for success

In summary, the opportunity set is rich. We think that both we and our clients need to adapt to the new normal and adopt strategies that are liquid and diversifying, and which can navigate less predictable market scenarios. This may require some investors to increase their appetite for complexity, sharpen their research (these are skill-based investments) and overcome biases from the previous decade. We anticipate that better performance from liquid alternative diversifiers over the last few years may help investors make the leap. 

Investors do not need to do it all on their own. If asset owners and asset managers like ourselves partner together, we believe there is a greater likelihood that market risks can be converted into opportunities for optimising future returns.

1 Quantitative easing is a monetary policy whereby central banks buy predetermined amounts of government bonds or other financial assets in order to stimulate the economy and increase liquidity.

2 Source: DeepSeek sparks AI stock selloff; Nvidia posts record market-cap loss, Reuters, 28 January 2025

3 Source: MSCI ACWI Index – Factsheet, 31 January 2025

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Authors

Catherine Doyle

Investment specialist