A recent webinar organized by IFA Magazine showcased valuable insights from experts at Legal & General Investment Management (LGIM) regarding the growing importance of alternative investments in multi-asset portfolios. Co-chaired by IFA Magazine editor Sue Whitbread and senior financial journalist Jenny Hunter, the session featured contributions from experienced LGIM fund managers Aimee Bowkett and James Giblin.
During the webinar, Aimee and James shared their expertise and perspectives on the vital theme of alternatives. Aimee succinctly captured the essence of the discussion: “In our latest webinar, we explore the advantages of diversification within the current market landscape and examine how increased allocations to alternative asset classes can enhance diversification. We also clarify what we mean by ‘alternatives’ in our investment strategies.”
To provide an overview of the key subjects discussed in the session, here are some highlights.
Defining Alternatives in Investment
The webinar began with an essential definition: what are “alternatives” in the realm of investing? Aimee Bowkett explained that alternatives encompass any asset class beyond the traditional trio of equities, bonds, and cash. The primary aim, she noted, is “to discover assets that offer different return drivers compared to conventional asset classes.” Ultimately, Bowkett emphasized, the goal is to secure superior risk-adjusted returns and enhance overall portfolio diversification.
James Giblin echoed this perspective, pointing out that while many managers remain predominantly focused on traditional asset classes, there exist substantial opportunities within alternative investments. He remarked, “If there’s a free lunch available, we should take it,” underscoring the diversification advantages that alternatives can offer.
Diversification Benefits of Alternatives
A central theme of the webinar was the immense diversification potential that alternative assets bring to the table. Aimee and James highlighted how diversifying investments across various asset types diminishes unrewarded risks, leading to more stable outcomes over time. Giblin illustrated this concept with a relatable analogy, comparing it to rolling multiple dice instead of just one—more assets generally result in a lower chance of extreme outcomes.
Aimee further emphasized that successful diversification goes beyond merely adding more assets; it hinges on the correlation between those assets. “Correlations are measured on a scale from minus one to one,” she stated. “The closer the correlation is to zero or negative, the stronger the diversification benefit.” She pointed out that low or negative correlations among asset classes—like equities and bonds—can offer significant stability during turbulent market periods.
However, both speakers acknowledged the dynamic nature of asset correlations, which can change over time. For instance, in 2022, the historically negative correlation between equities and bonds shifted to positive, creating challenges for the classic 60/40 investment strategy. “It was the worst year on record for the 60/40 portfolio,” Bowkett remarked, highlighting the necessity of incorporating alternatives to manage such risks.
Exploring Alternatives Beyond Bonds
The discussion progressed to address how alternatives fit within a broader portfolio strategy, especially in an environment where bonds are less reliable for diversification. Giblin explained that the rise of inflation and subsequent monetary policy adjustments have disrupted the traditional equity-bond relationship. “While we believe bonds remain essential to multi-asset portfolios, particularly during a demand shock recession, the pressures of rising inflation could compromise their protective role in certain circumstances,” he noted.
This is where alternatives become crucial. Aimee pointed out that assets such as listed infrastructure and real estate investment trusts (REITs) can provide valuable diversification and serve as inflation hedges. “Infrastructure assets, like utilities and transportation, tend to generate stable cash flows and can be tied to inflation,” she said, indicating their worth during times of price increases. Giblin further explained that alternatives like high-yield bonds and emerging market debt also present opportunities to diversify beyond traditional fixed-income options. “We’ve developed a tool called the ‘correlation galaxy’ to visualize how different asset classes interact,” he added, stressing the importance of identifying “intergalactic stars”—assets that show minimal or no correlation with traditional stocks and bonds.
Thematic Investing and Alternative Credit
The conversation shifted to thematic investing, with both fund managers discussing how recognizing persistent structural trends can introduce varied return profiles into a portfolio. Giblin explained that thematic equities—themed around initiatives such as clean energy or artificial intelligence—are often viewed as alternative investments. Despite potential short-term correlations with broader equity markets, over time, they can deliver distinctive performance.
Aimee also highlighted the role of alternative credit within multi-asset portfolios, referencing assets like high-yield bonds and emerging market debt. Although these higher-risk, higher-yielding assets can enhance diversification and increase portfolio income, she cautioned that current valuations may render them less appealing in the short term due to potential overvaluation.
Balancing Active and Passive Approaches in Alternatives
A recurring query from the audience concerned LGIM’s approach to balancing active and passive strategies within their portfolios, particularly regarding alternatives. Giblin clarified that while passive strategies may thrive in many asset classes, certain areas—like high-yield bonds—benefit immensely from an active management approach. “When working with high yield, an active manager is invaluable for navigating the risks posed by issuers with heightened default risk,” he asserted.
Aimee added that active management is equally essential in the infrastructure sector, particularly concerning ESG (environmental, social, and governance) investing. “In such a vast investment landscape, an active approach allows managers to effectively manage risks and select companies aligned with sustainability objectives,” she elaborated.
The Future of Alternatives
Looking forward, both Bowkett and Giblin conveyed optimism about the future role of alternatives in investment portfolios, especially amid economic uncertainty. Bowkett noted the defensive qualities shared by many alternative assets, which could provide reassurance to investors grappling with potential recessions or inflationary challenges. “I believe alternatives will continue to serve a crucial function in diversification and safeguarding against downside risks,” she stated.
Giblin concurred, noting that while alternatives may be more challenging to access and manage, they present significant long-term advantages. “Our team of strategists and economists works diligently to monitor these assets,” he said. “For managers who overlook alternatives, they may be missing out on considerable opportunities.”
Conclusion
The LGIM webinar provided comprehensive insights into how alternative assets can enhance diversification and optimize risk-adjusted returns within multi-asset portfolios. As traditional bonds face hurdles and equity markets experience increased volatility, assets such as infrastructure, REITs, high-yield bonds, and thematic equities are becoming increasingly critical for financial advisers seeking to build resilient portfolios for their clients.
