Are these the Alternative Investment Strategies You’ve Been Looking For?

by | Apr 27, 2017 | Alternative Income, Hedging, Option Trading

When you’ve been writing and talking as much about the need for portfolios to use alternatives and hedging as much as we have, seeing an increase in stories pointing to the same thing are encouraging. Yet as the title inspired by Star War’s Obi Wan Kenobi asks, are the alternatives being considered the right ones? Do they reduce rather than increase risk to a portfolio?

Recently a story in the Arizona Republic’s online site AZCENTRAL highlighted a few points. First, the pension funds mentioned pay high outside management fees. They cite using alternatives as the reason why fees must be so high. The fund, per the article, has underperformed its 7.5% annual return target and has been moving more to alternatives like owning real estate and private equity.

Another article by the same AZCENTRAL delved further into issues pension funds are facing. CalPERS (California State’s huge pension) lowered their annual expected returns down by 50 basis points from 7.5% to 7%. This piece also highlighted how many funds are now reaching for yield with bonds at near record lows in interest rates. In 1990 it was pointed out CalPERS held 50% in bonds and cash but today they report only 20% in those same classes.

The article even gave the example of the South Carolina Retirement System going from only holding bonds and cash in 1997 to today only 12%. According to AZCENTRAL the rest is in equities and “other” potentially volatile investments.

The problem for pensions is that when paying out defined benefits, they rely on certain return assumptions to pay out future benefits. If they wind up projecting a shortfall due to poor returns, they need to either cut benefits or have the guarantor inject more equity. Neither one is the ideal solution. So, they feel the pressure to sharpen their pencils and get better returns!

Naturally one might expect managers to seek out other investments that provide a greater chance at achieving their stated annual return goals. Yet as we asked in the title, are they the right alternatives?

Taking the extreme example of the South Carolina Retirement System, if they are actually holding that high a percentage of equities, doesn’t that create the possibility in a downturn of creating more risk in a portfolio? This reach for yield might potentially end badly. Comparing the total returns and standard deviation of bonds to equities should highlight how much more volatile the equity asset class is. Especially when unhedged or not buffered.

With ZEGA’s alternative strategy lineup, many look to provide positive risk adjusted returns. For pension funds that use equities, we might suggest our Buy and Hedge strategy which provides the good of capturing most of the upside while cutting the downside risk with built in floors. Our ZBIG (ZEGA Buffered Index Growth) strategy aims to provide the upside with a downside buffer in order to suspend losses until the market moves below a much lower level.  Click here for more information on ZBIG. Other strategies offered aim to generate returns in various market environments even when the markets are flat.

If you are running or involved in the management of a pension fund or retirement plan, why not schedule some time to talk about how you can look to use alternatives the right way and potentially reduce your risk while doing it.