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Three Alternative Investment Ideas for Dislocated Markets

Ryan Korinke, Head of Hedge Fund and Quant Strategies discusses three alternative investment strategies that may help investors capitalise on market dislocations such as we saw in March.

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Photograph of Ryan Korinke, Head of Hedge Fund and Quantitative Strategies

Ryan Korinke: Most of our alternative conversations with investors over the last few weeks have really focused on how to capitalize, how do I take advantage of these conditions and these dislocations.

I would say now they're starting to increase as far as people looking for ways to diversify. Either everyone’s now had some time to regroup and say, “Wow, March was a little bit rougher than I wanted or I liked or I realized I had tolerance for.” Or they're saying, “You know, look, March was okay, but, wow, we've had a nice strong rally the last two months. I'm worried about some of the uncertainty, things like election in the US later this year, trade and geopolitical tensions that continue to be around. And so, maybe I should look for some trading strategies or asset classes that held up well in the beginning of 2020 in case we start to have that type of volatility.”

A couple of things I would highlight there, first, would be trend following or time series momentum.

To put it simply, the basic idea is that, in general, prices that are going up continue to go up and, in general, prices that are going down continue to go down and the idea behind that is that humans are just slow to incorporate new information. And so, maybe there’s a new economic release that comes out, or maybe there's a new corporate piece of information that comes out. And yes, the price goes up because of that release, but it doesn't go up as much as it should, because people just don't reflect that new fundamental information as quickly as they should.

This was an area that historically has had very negative correlation to equities, particularly in more stressed environments. We saw that in the beginning of 2020. So if you look at the Soc Gen Trend-Following Index, it was up about 2.7% in the first four months of 2020. At a time when equities are down 10-15% depending on the index.

In general, we think when you have markets that are moving quickly, responding to uncertainty, repricing, trend followers are able to pick this up, put on the short-risk asset positions, put on the long-bond positions or short difference currency, long difference currency positions, quite quicker and respond to that than we might be able to pick up on. And thus, give you that much more favorable correlation diversification properties. So we think that's an interesting space to continue to look at.

The second one that I would mention would be insurance-linked securities. If you look at the Swiss Re Cat Bond Index, that was up about 65 basis points for that same January to April period at the beginning of the year.

Looking forward, we think it's interesting, because if you look at what the pandemic has done on the insurance industry more broadly, some insurers and reinsurers have exposure to things like event cancellation insurance or business interruption insurance. So if you listen to some of the insurance and reinsurance quarterly earnings calls, many of the executives on these are talking about a hard market. Which simply means there's less capital for new deals and for premium renewals. So that, as a result of that, yields are going up.

Finally, I would say that we still think that multi-strategy, multi-asset class systematic strategies are another interesting area. What I would say is that there was also a wide variety of signals or trading strategies that we follow, and often times implement, that fared very well during the Coronavirus-induced February, March sell-off. So we think that's an interesting area to consider. If you think about it, it makes sense. It was really hard in March to do something bold, to buy things that had cheapened out, or to avoid doing things that you might later regret, sell things that maybe were going down in price but hadn't really changed in value. But a computerized or a systematic strategy doesn't face that same bias, and so that can be very helpful in these types of scenarios.

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Disclosure


Past performance is not a guarantee or a reliable indicator of future results.

All investments contain risk and may lose value. Hedge funds and other alternative investments involve a high degree of risk and can be illiquid due to restrictions on transfer and lack of a secondary trading market. They can be highly leveraged, speculative and volatile, and an investor could lose all or a substantial amount of an investment. Alternative investments may lack transparency as to share price, valuation and portfolio holdings. Complex tax structures often result in delayed tax reporting. Private placements are subject to less regulation and often charge higher fees. Alternative investment managers typically exercise broad investment discretion and may apply similar strategies across multiple investment vehicles, resulting in less diversification. Trading may occur outside the United States which may pose greater risks than trading on U.S. exchanges and in U.S. markets.

Trend-following is a strategy that seeks to make profits by capitalizing on the long-term general direction of a market trend. Trend-following typically Involves the use of proprietary trading systems and primarily managed futures strategies, to react to price trends in various global markets. Managed futures contain heightened risk, including wide price fluctuations and may not be appropriate for all investors. Long/short managers seek to produce equity-like returns without the typically higher volatility associated with long-only strategies. Long is buying an asset/security that gives partial ownership to the buyer of the position. Long positions profit from an increase in price. Short is selling an asset/security that may have been borrowed from a third party with the intention of buying back at a later date. Short positions profit from a decline in price. If a short position increases in price, the potential loss on an uncovered short is unlimited.

Insurance-linked instruments provide exposure to various insurance risks and are tied to a varied group of available perils and geographic regions. Such perils will consist, amongst others, of earthquake, flood, hail, wind or other weather-related risks, and may include exposure to other natural or non-natural catastrophic events. Examples of insurance-linked instruments include, but are not limited to, securities or other financial instruments linked to excess of loss, quota shares or other reinsurance or derivative risk transfer contracts, catastrophe bonds, industry loss warranties, sidecars, over-the-counter financial derivatives, listed derivatives (i.e., futures/options on futures) and equity and/or debt securities. of insurance and reinsurance companies. The performance of insurance-linked instruments depends on the occurrence or non-occurrence of specific insurance events, including such catastrophic events mentioned above, and the incidence, frequency and severity of such catastrophic events are inherently unpredictable.

Multi-strategy and absolute return portfolios may not fully participate in strong positive market rallies. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be appropriate for all investors. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested. The use of leverage may cause a portfolio to liquidate positions when it may not be advantageous to do so to satisfy its obligations or to meet segregation requirements. Leverage, including borrowing, may cause a portfolio to be more volatile than if the portfolio had not been leveraged. Diversification does not ensure against loss.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

Performance should never be the sole consideration when making an investment decision. The referenced indices are shown for general market comparisons and are not meant to represent any particular PIMCO product or investment strategy.The correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility. The SG Trend Index calculates the net daily rate of return for a group of 10 trend following CTAs selected from the largest managers open to new investment. The SG Trend Index is equal-weighted and reconstituted annually and has become recognized as the key managed futures trend following performance benchmark. The Swiss Re CAT Bond Index tracks the aggregate performance of USD denominated catastrophe bonds offered under Rule 144A. The index captures all rated and unrated cat bonds, outstanding perils, and triggers and seeks to capture the overall universe of USD-denominated cat bonds. It is not possible to invest directly in an unmanaged index.

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