Financial advisors are increasingly adding asset classes and strategies to their recommended investment mix that are designed to level the bumps and stop fearful clients from heading for the hills when markets plunge.
Included in the choice of investments aimed at minimizing risk are low-volatility and defensive stocks, protective put and call option strategies, private debt and equity, and limited short-selling techniques. Once the domain of institutional investors and hedge funds, many of these strategies are available through mutual funds and ETFs, making them accessible to all types of investors.
"We are taking the principles of risk management from the alternative strategy/hedge fund industry and democratizing them," says Som Seif, president of Purpose Investments Inc. of Toronto, which offers a family of ETFs and mutual funds that includes several products offering downside protection.
Clients may grasp the concept of committing to their holdings for the long term, but when the value of their investments plunges, their fearful emotions can take over. Giving clients exposure to strategies with a low correlation to traditional stocks and bonds can provide a better risk/return experience by increasing portfolio diversification, lowering volatility and enhancing returns — all of which encourage better investor behaviour in committing to their long-term plan. Holdings offering downside protection act as "crisis alpha," acting as stabilizers to a portfolio when traditional equities or bonds markets melt down.
Several mutual fund providers, including Mackenzie Financial Corp., CI Investments Inc., Franklin Templeton Investments Corp., and the Dynamic Funds family of 1832 Asset Management LP (all based in Toronto) and Hesperian Capital Management Ltd. of Calgary, offer funds that use various strategies designed to enhance returns or limit losses in down markets. Some are labelled as alternative strategy vehicles, such as Mackenzie Diversified Alternatives Fund.
Purpose offers several products in both mutual fund and ETF format, including Purpose Diversified Real Asset Fund, Purpose Tactical Hedged Equity Fund and Purpose Multi-Strategy Market Neutral Fund.
"We bring alternative strategies to the retail investor in a low-cost, transparent, high-quality product," says Seif. "We don't think of these as risky strategies, we think of them as risk-management strategies."
Toronto-based Horizons ETFs Management (Canada) Inc. also endorses alternative strategies as a portfolio diversifier and offers several ETFs that are non-correlated to traditional markets, including precious metals, currency and bear market ETFs.
This suite of products includes Horizons Absolute Return Global Currency ETF, which offers long and short exposure to global currencies, and Horizons Global Risk Parity ETF, which invests in a wide array of asset classes including global equities, global fixed-income instruments and inflation hedges, such as gold bullion and real estate.
The lineup also includes Horizons Auspice Broad Commodity Index ETF, Horizons Auspice Managed Futures Index ETF and Horizons Morningstar Broad Hedge Fund Index ETF. The last of these ETFs replicates the performance of the Morningstar broad hedge fund index created by Morningstar Inc. of Chicago, tracking the performance of 600 to 800 hedge funds in the index.
"It's as if you've put all the ‘smart money' together in one product," says Mark Noble, senior vice president and head of sales strategy at Horizons, of the broad hedge fund ETF. "You're getting the aggregate performance of hundreds of hedge funds. The average investor who has stuck to traditional stocks and bonds needs to recognize the extreme importance of additional diversification."
Traditional bond portfolios offered in both mutual funds and ETFs are a less attractive diversifier than in the past as bonds are vulnerable to losing market value when interest rates rise and investors need to protect their portfolios on the fixed-income side as well.
Useful risk-minimization strategies in the bond arena could include exposure to preferred shares, short-term and floating-rate securities and higher-yielding global bonds as well as "duration neutral" portfolios that may use some hedging techniques to protect against rising interest rates.
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