Sarah de Lagarde: Well, now it’s time to find out more about the democratisation of alternatives, where, when and how that impacts investors. So, we’ve got for you David Elms, head of diversified alternatives, Luke Newman, absolutely return portfolio manager and Adam Hetts, head of portfolio construction and strategy. Adam, I’m told you’re facilitating this session, so I’m handing over to you.

Adam Hetts: Okay, thank you, Sarah, and thanks to everyone in the audience for joining. Like you just heard Alex Crooke say, there’s a big tug of war in markets right now and the portfolios between offence and defence, which really makes this environment right for alternative strategies.

So, I’m pleased to introduce my panellists, David Elms and Luke Newman, as Sarah just said. Also, I’m Adam Hetts, global head of portfolio construction and strategy. So, I run a global team of strategists that are meeting with Janus Henderson’s clients every day and we’re providing proprietary analysis and insights on their asset allocations.

So, since launching this team, we’ve met with over 5,000 clients and analysed over 15,000 client portfolios. Over the last year, my team has been asked more about alternatives than maybe the last ten years combined. The average client allocation to alternatives in our database of client portfolios is growing. So, I think this is a great topic today and one we’re going to be focused on for years to come.

So, David, we’ll start with you and I’ll be gentle and start simple. How are you defining alternatives for the purposes of today’s conversation?

David Elms: For the purposes of today’s conversation, thanks, Adam, for the introduction, I’m focusing on liquid alternatives. By liquid alternatives, I’m talking about what it is what Janus Henderson does in this space as things stand today. We don’t do… In liquid alternatives, we don’t do private credit, we don’t do private equity, which are interesting parts of the alternatives space. In fact, you could argue from some perspectives, are they really alternative or not? Are they really just less liquid versions of standard assets like credit and equity? But that’s another discussion.

So, the focus here is liquid alternatives. It’s where a client can receive their money back in typically a one month or less horizon. That’s a reasonably definition of liquid alternatives and it means that the underlying investments are typically standard securities rather than being partnerships ventures and less liquid funds and so forth. It’s not exclusively the definition, but it’s a good definition for what we’re here to talk about today.

Adam Hetts: Thanks, David. Luke, I’ve got a different question for you, but first anything you want to add on defining alternatives in your opportunity set, or should I just move on?

Luke Newman: No, I think that was a comprehensive explanation.

Adam Hetts: Okay. So, then the next question would be, as we’re seeing more clients moving to alternatives, because of the market environment and the comments I just made about our client portfolios growing their alternatives allocation, how do you see clients using them in portfolios, Luke? In other words, what are the biggest problems you think clients are trying to solve with liquid alternatives right now?

Luke Newman: Thanks, Adam. Yes, a really interesting question and an important starting point to look at when we’re thinking about alternative assets in general, our provision of them and, as you say, how we’re seeing them used in markets and ultimately by end investors. It’s something we’ve seen change over the last couple of decades, as certain elements of that alternative market have matured and we’re part of that maturity process with those products.

I would say really there are three areas we’ve seen alternative products being used by asset locators and investors. The first I would say are sold in and substituting areas of portfolios traditionally provided by long equity products and generally investors are aiming to replicate or get close to equity-like levels of return, but without taking the associated levels of risk.

We can all think of those dramatic drawdown events and bear markets we’ve seen over the last few decades, and also the appeal of more alternative assets that over the long-term can deliver similar levels of returns, but maybe take out some of the volatility along the way.

Equally, we’ve seen periods where alternatives have substituted fixed income type assets and we almost see investors investing on a risk budget basis, rather than necessarily targeting a return. Again, that’s a period we’ve seen as well.

The final category is probably the one we feel most comfortable with, and I think it’s also a trend that has been in place and seems to be accelerating. That’s investors allocating more of their portfolio to alternatives as a diversifying asset class in its own right.

So, holding more liquid alternative type assets, and that poses the question, why would you do that? It speaks to your introduction and to what David was saying before. Why on earth would you do that? Well, if done correctly, alternatives could provide that uncorrelated return, so giving you vehicles and fund within portfolios that can deliver consistent ongoing performance.

Secondly, I would describe them as shock-absorber type characteristics. That has really been front and centre in recent years. The sort of protection that alternative funds can give to investors… We’ve seen this first-hand here at Janus Henderson in terms of the protection of those funds through pandemics, recessions, referendums, elections, all of those periods of volatility. Actually, the predictability is another reason why those allocations have increased.

The final piece really is alpha generation and that’s something that we can see coming more into focus on a forward-looking basis, but actually the appeal of consistent stable levels of absolute performance again I think looks pretty attractive in certain environments. So, that’s why we’ve seen, I think, the usage of alternative assets increase in recent years.

Adam Hetts: It sounds relatively straightforward. Uncorrelated shock-absorbers and alpha. David, anything to add to that?

David Elms: I think, and I’m careful about preaching to the converted here with your hosting us, Adam, but I think it’s about the investor’s broader portfolio as well. So, you can’t think of alternatives in isolation. You’ve got to think of what is going on in the background for investors with everything else. That’s both at a headline level… So, think of 2022, when we had significant drawdowns in equities, significant drawdown in bonds and if you were in conventional assets, those more vanilla assets, there really was nowhere to hide.

So, that’s important and that creates the interest, but also unpeel the onion an extra layer and think about the composition of a portfolio. If your equities and bonds are going up and down together, so they have positive correlation, then that is a riskier portfolio then if they’re going in opposite directions, which is really what we saw for most of the past 25 years or so. You need to go back to the late 90s to see a period like we’ve seen recently, where equities and bonds to up and down together.

So, where you end up in a portfolio sense is that the two major asset classes that make up the majority of most investors’ portfolios, if they move together in sync, then that’s a riskier portfolio. If they diversify each other, it’s a less risky portfolio. So, picking up Luke’s point about risk budgeting investors, if they’re thinking about a broader portfolio, they’re going to want to find other things to do when the major assets in the portfolio [unclear] are positively correlated. I think this is where alternatives become attractive to asset allocators and it’s going to drive…

Not just in terms of the headlines, the obvious reason to move to alternatives, but in terms of that second layer more quantitative argument that’s going to drive heavier allocations or alternatives. So, I think this is an important change to market conditions and it’s really significant as to whether this persists or is something that is a shorter-term phenomenon. Historically, it has persisted for really long periods of time, so that’s something to be concerned about and aware of.

Adam Hetts: Okay, so we’re looking to alternatives as that uncorrelated shock-absorber, whether investors are concerned about equity volatility, or fixed income rate volatility, or even, David, to your point, the traditional 60/40 going through a paradigm shift of how the 60 and the 40 interact and having alternatives maybe intermediate some of that.

So, if you’re looking for all those benefits in the liquid alternative strategy, then what’s most important when it comes to manager selection in this place? I’m not sure if David or Luke, you want to start talking about manager selection.

Luke Newman: I would say survivorship bias is such an important factor in this space. We see it ourselves. You see new strategies launched and some burn brightly for a short period, then we see a long tail of strategies that haven’t delivered in the space. They haven’t delivered to those objectives, targets and outcomes that we talked about at the start there.

So, I would say consistency of process, consistency ultimately of performance is critical, but actually it goes with the territory here. It’s consistency and predictability of the return characteristics as well and I would say those are the areas we tend to encourage our investors to assess and monitor going forward.

It’s not about knocking it out of the park necessarily with alternatives. It’s consistency, it’s being there for the difficult markets, the difficult economic cycles, as much as the easier environments where alpha generation presents itself more readily.

David Elms: Yes, I definitely agree. I think the two things that we’ve spoken of a few times already, but alternatives need to generate attractive risk adjusted returns. They need to make an investor’s portfolio accrue value in that sense, but they also need to do it in a different way. If they only do it when equities are going up or bonds are going up, then in what sense are they really an alternative? So, I think your alternatives need to be that alternative to traditional assets to add something to an investor’s portfolio.

So, looking at measures like how much of a return of a portfolio is accounted for by the change in equity markets, or the change in interest rates is important. Because investors carry that exposure significantly in any case. I would definitely echo Luke’s comments about the ability to do this in the long-run over different cycles, the consistency of the investors in that process, the consistency of the investor process.

I think also in the case of what we do, which is multi-strategy, the ability to adapt to different market environment. So, what worked five years ago or ten years ago doesn’t necessarily work today and the ability to adapt an investment process for different market environments is also very important. Markets are always getting harder to invest in and it’s a never-ending challenge in that regard.

Adam Hetts: So, at this point, I’ll open it up to any more audience questions I see coming in on my screen and I’ll start with this one, speaking of markets getting more difficult. Any comments from either of you on the US debt ceiling and if it might create any unique opportunities for you as alternatives managers?

Luke Newman: It might seem counterintuitive, but actually this environment for equity long-shorts, so slightly distinct but not totally from what David does, I would say we’ve been enjoying this environment. Yes, it’s uncertain, but actually it’s a lot more rational. I think it’s probably to do with the fact that we’ve emerged from this long period of QE dominated, low discount rate, low risk-free rate, environment, to one that feels more normal.

We remember this period. We remember investing with rates and inflation at these sorts of levels. Now they’ve settled down a bit. So, that’s helpful and actually I think a good proof statement of that is how we’ve been able to protect against the increasing fears in the market [unclear], around the debt ceiling. We looked back historically and 2011 was the case study for us in terms of what happens if things don’t get resolved ahead of the date.

This work started two or three months ago and we’re not reactive. We’re always looking ahead and actually so far history has rhymed a little bit. Actually, pressure on domestic US assets, pressure on US consumer discretionary sectors in particular. We’ve been able to protect about that on our short book and adjust the long book slightly.

Pressure on the dollar, and again then actually there are ways of protecting within US markets against that, but actually there are a lot of ways- There are a lot of UK and European listed businesses that have a lot of their earnings in dollars and then translate them back into Euros and Sterling. So, again, that needed some thinking about.

Then very quickly, in 2011, what was initially a US issue for obvious reasons very quickly had a global GBP knock-on. Then, as now, we’ve seen pressure on commodities. Oil, materials. Again, that has provided volatility for the market, but I would argue so much more rational than we’ve seen for much of the last decade.

So, actually, first and foremost, protect, along the line that I’ve just mentioned. But then really, for a fund like ours, it actually becomes an opportunity to find alpha and again find another way of shock-absorbing first and foremost, but actually delivering that consistent, stable, positive absolute return and that has been our experience over the last few weeks and months.

David Elms: Yes, it’s a really interesting environment and I think back to some of the big macro events that we’ve had, big macro and political events that we’ve had over the past few decades. I think these things in a sense are becoming harder to predict. So, even if you knew, say, the outcome of the US election in 2016, you may not have been able to make money even with perfect foresight.

I think this means that market positioning is a significant factor. So, we look at something like the debt ceiling and the potential risk, the two-sided risk because there is some bearishness and positioning ahead of it, but I think there is also an assumption that as in 2011, they will find a way through. That sensible minds will come together, compromise will occur and everything will be all right.

That has generally been the case, but you also have a far more polarised political environment than you had back in 2011 and I think the makings of a compromise whilst in one sense obvious, are going to be harder to achieve. So, when we think about this sort of thing, we’re thinking about almost radical uncertainty.

It’s a bit like Donald Rumsfeld’s Unknown Unknowns. Even if you have a crystal ball that tells you what’s going to happen, in the real world, the way the market is going to react can be totally counterintuitive. So, in this kind of environment we rely more on non-directional strategies that do very well in large moves in either direction. So, I’m thinking about strategies that have more optionality, that use derivative markets to get those positively complex payoffs. So, they do well in big [?] moves up, they do well in big moves down, and this is a good environment for running that sort of risk profile in a fund.

Adam Hetts: Thanks, David. Thanks, Luke. I think that about wraps us up. It gets us pretty close on time. If I had to sum this up in one sentence, it’s probably going back to the beginning that the environment doesn’t point to a straightforward approach to just defence or just offence in portfolios, and if my team’s portfolio consultations are any kind of leading indicator, we’ll continue to see more inflows into the space based on the conversations we’re having.

I think, Luke, as you put it, those uncorrelated shock-absorbers that could potentially generate alpha, seem like the great solution to balance that offence and defence in investor portfolios. So, thank you both for your comments. That was great. Thanks again to the audience for joining us and thanks for your interest in liquid alternatives.

We’re of course happy to have any follow-up conversations after this session, or share any of our team’s thought leadership, or anything else we can do with all of you to keep the conversation going.