Correlation dilemma gives liquid alternatives their time in the sun

Liquid alts will only become more in demand if the positive relationship between bonds and equities remains sticky, Harrex explained. Investors will need another diversifier, and the liquidity will only make them more attractive.

What if the breakdown of the negative bonds-equities correlation in 2022-2023 was not an aberration, but a return to the positive correlation that prevailed as recently as 1980–2000? Andrew Harrex, managing director, Australia and New Zealand, at P/E Investments, posed this question to The Inside Network’s Alternatives Symposium.

If so – and P/E Investments believes it is – “investors are going to need another diversifier,” Harrex said.

Harrex presented the P/E Global FX Alpha Fund, offered through the Macquarie Professional Series, which uses a systematic approach to currency derivatives trading to generate returns with low long-term correlations to bonds and equities – and negative correlations to equities in periods when the stock markets are down.

It’s a daily-liquidity strategy, so considered a ‘liquid alternative’. Harrex stressed that ‘liquid alts’ strategies are a very heterogenous group, that will not all behave the same – in the GFC year of 2008, performance dispersion was –70 per cent to 110 per cent – and that ‘liquid alts’ will come into their own if bonds and equities continue to show positive correlation.

“We think that alternatives will be needed more than ever as an effective diversifier, and liquid alternatives will be more efficient than illiquid alternatives that claim an illiquidity premium,” he said.

The Global FX Alpha Fund generates its return in the most liquid market in the world – global foreign exchange – but also the most inefficient. And that’s the manager’s edge.

“US$7 trillion of currency is traded every day; but half of that is non-profit-maximising,” says Harrex. “Those trades have to accept the price that day, because they’re related to trade or cross-border transactions. That makes it a very inefficient market – which creates tremendous opportunities for us,” Harrex told the symposium.

He said the strategy filled a number of roles in P/E Investments’ clients’ portfolios; as a return smoother, a growth play and a diversifier.

In the same session, Razvan Remsing, director of investment solutions at London-based Aspect Capital, presented a strategy that demonstrated the heterogeneity of liquid alts. Where P/E Investments harvests return systematically from one market that hides in plain sight for most investors, Aspect Capital (distributed in Australia by CFS) harvests it from dozens of them. It is a trend-follower, and it doesn’t particularly care where it finds a trend worth following.

“We trade all the liquid capital markets – futures, forwards, interest rate swaps, financials, commodities, it doesn’t matter,” Remsing said. “We trade about 250 different markets, across eight asset classes, that capture the macro universe. We’re looking to capture persistent trends.”

Aspect has positions in all of the markets at all times, he said, “because we don’t know where and when the next trend is going to start”. It runs about 50 trend-based models that drive those positions, and is agnostic as to whether it goes long or short.”

Not all trends behave the same, he said; Aspect looks for trends running from inside a week, to six-to-nine months. That builds-in another layer of diversification in the Aspect Diversified Futures Fund – diversification by term of trend.

The daily-liquidity strategy has “almost no correlation” to stocks, bonds or commodities over the cycle. “Moreover, we have meaningful negative correlation to equities markets and bond markets when they’re falling – which gives us that ability to be a shock-absorber in a portfolio,” Ramsing said.