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The term ‘Alternatives’ within the investment world typically refers to two types of strategies:
- those that invest in assets other than traditional investments like stocks, bonds and cash; or
- those that take a non-traditional approach to investing such as long/short funds, strategies that arbitrage, benchmark unaware and unconstrained funds.
The main reason why investors choose to hold alternative assets in their portfolios is that the returns tend to be uncorrelated with those generated by more traditional stock and bond investments. So, alternatives can provide broader diversification, which can help reduce the risk profile of a portfolio and potentially also enhance returns.
Alternative fixed income – think ‘unconstrained’
Unconstrained fixed-income strategies are considered ‘alternatives’ because they take a non-traditional investment approach – they do not invest relative to a formal benchmark. Instead, they hold discretionary exposure to various types of fixed-income assets that have differing risk attributes. In short, they are benchmark unaware – the fund manager can choose what to invest in and how much to invest without reference to a benchmark index.
Sectors that make up the unconstrained fixed-income universe include global sovereign debt, corporate investment grade credit, high-yield credit, bank loans, mortgage and other asset-backed securities, and emerging market debt, amongst others.
Since unconstrained strategies are not tied to any benchmark’s sector allocation, they can take advantage of attractive market opportunities, placing more (or less) emphasis on sectors that they prefer (or dislike).
The most common argument for unconstrained fixed-income investing rests in the inherent shortcomings of fixed-income benchmarks. In particular, the paradox that the countries with the largest weights in fixed-income benchmarks are those with the most debt (US, Europe and Japan) but highly indebted countries don’t always stand out as the best investment opportunities. Global fixed-income benchmarks also continue to have a high exposure to securities with low yields, with a large portion of Japanese and European Government bonds yields remaining negative.