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Goldman Sachs Asset Management Statement on the Russia-Ukraine War. Read it here.    

April 29, 2022 | GSAM Connect

Liquid Alternatives: Why Now?

Many investors came into 2022 with their eyes wide open. Elevated equity valuations, waning policy support and higher interest rates suggested that it was probably time to start thinking about some strategy changes. Since then, geopolitical unrest has only confirmed the need to reassess expectations and asset allocations.

And when it comes to change, evidence suggests investor minds are open, too. As core equities and fixed income have struggled year-to-date, alternative mutual funds have recorded net inflows of more than $11.6 billion1. Also known as liquid alternatives, these funds often have characteristics similar to hedge funds but are public vehicles that can be traded easily. Many offer investors a higher degree of diversity and flexibility, such as the ability to take long and short views on specific assets, and have few or no ties to traditional benchmarks.

But despite the recent inflow, a review of 9,500 professionally managed portfolios using our proprietary GS PRISM™ portfolio analysis tool found that the average allocation held by financial advisors in recent years was just 3.8%. Moreover, the majority of advisors in 2021—62%—hold nearly no allocation (less than 1%)2.

We think there is a case to be made for increasing those allocations. The way we see it, liquid alternatives offer two potential advantages.

First, we believe they may reduce the effects of severe equity drawdowns.

Since 1990, during periods where the S&P 500 Index fell 15% or more from its peak, diversified liquid alternatives outperformed US large cap equities by between 13 and 47 percentage points (pp). Exposure to these assets during volatile market environments may help investors avoid emotional selling, maintain a long-term investment perspective, and participate in subsequent rebounds.

Exhibit 1: Liquid Alternatives Vs S&P 500 During >15% Drawdowns

EXHIBIT 1: LIQUID ALTERNATIVES VS S&P 500 DURING >15% DRAWDOWNS

 

Exhibit 1: Source: HFR, Bloomberg, and Goldman Sachs Asset Management. Starting point selected given longest common index inception (HFRI FoF inception 1/1/90) through 3/31/2022. Challenging equity environments are defined as periods in which equities realized at least a 15% drawdown using monthly data. Outperformance figures shown are cumulative performance differential during each equity bear market or period of rising rates. S&P 500 is represented by the S&P 500 TR Index. Liquid Alts. is represented by the HFRI Fund of Funds Index. HFRI and related indices are trademarks and service marks of Hedge Fund Research, Inc. ("HFR") which has no affiliation with Goldman Sachs Asset Management. Information regarding HFR indices was obtained from HFR’s website and other public sources and is provided for informational purposes only. HFR does not endorse or approve any of the statements made herein. HFRI FoF index shown as representative of absolute return strategies. The S&P 500 and Bloomberg US Aggregate Bond Index are shown as market indicators for core stocks and core bonds respectively, as they represent the most widely followed industry benchmarks. For illustrative purposes only. Past performance does not guarantee future results, which may vary. Past correlations are not indicative of future correlations, which may vary.

 

Second, we think liquid alternatives may provide positive returns during rising rate environments.

Historically, diversified liquid alternatives have outperformed the Bloomberg US Aggregate Bond Index by between three and 25 pp during rising rate environments. Liquid alternatives tend to have both low beta (0.1) and correlation (0.1) to investment grade fixed income, providing an alternative source of returns in rising rate environments, which have historically generated low returns for fixed income assets.

Exhibit 2: Liquid Alternatives vs US Agg During Rising Rate Environments

Exhibit 2: Potential Impact of a $30/bbl Price Shock on 2022

 

Exhibit 2: Source: HFR, Bloomberg, and Goldman Sachs Asset Management. Starting point selected given longest common index inception (HFRI FoF inception 1/1/90) through 3/31/2022. Rising rate environments are the steepest rising rate environments, as defined by the pace of change (rate increase/month), based on month end US 10-Year Treasury yields since 1990. Outperformance figures shown are cumulative performance differential during each equity bear market or period of rising rates. Liquid Alts. is represented by the HFRI Fund of Funds Index. US Agg is represented by the Bloomberg US Aggregate Bond Index. HFRI and related indices are trademarks and service marks of Hedge Fund Research, Inc. ("HFR") which has no affiliation with Goldman Sachs Asset Management. Information regarding HFR indices was obtained from HFR’s website and other public sources and is provided for informational purposes only. HFR does not endorse or approve any of the statements made herein. HFRI FoF index shown as representative of absolute return strategies. The S&P 500 and Bloomberg US Aggregate Bond Index are shown as market indicators for core stocks and core bonds respectively, as they represent the most widely followed industry benchmarks. For illustrative purposes only. Past performance does not guarantee future results, which may vary. Past correlations are not indicative of future correlations, which may vary.

 

As markets enter what looks likely to be a more muted return environment, we believe investors may want to consider adding liquid alternatives to their total asset allocation.

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ABOUT THE AUTHOR

Izabella Goldenberg

Izabella Goldenberg

US Head of Portfolio Strategy, Strategic Advisory Solutions, Goldman Sachs Asset Management

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