Alternatives
This is a marketing communication for professional investors only.
Capital at risk. Past performance does not predict future returns.
You could argue that with the 10-year rate at 4.5% whether portfolios need an allocation to alternative assets. Relying solely on bonds presents significant challenges. The traditional 60/40 portfolio is built on the assumption that equities and bonds are negatively correlated during market downturns—a notion that was upended in 2022 when both asset classes suffered steep declines, resulting in a historic underperformance of the 60/40 mix. When investing in alternatives, it not just about whether they can beat cash, but rather can they help protect portfolios during inflationary shocks whilst improving the efficient frontier.
For my alternative’s allocation, I aim to achieve three key objectives:
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Crisis Alpha: Generate significant positive returns during periods of crisis when market volatility surges.
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Protection from Sustained Drawdowns: Deliver positive performance during prolonged market downturns, especially in scenarios where both equities and bonds are declining simultaneously.
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Long-Term Diversification: Go beyond simply holding non-equity and non-bond assets. The returns should be genuinely uncorrelated with equities and bonds and should also outperform cash over the long term.
When evaluating the effectiveness of each investment, I focus on three key factors:
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Reactivity – The magnitude of returns generated during a market crisis.
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Carry – The expected returns during normal markets conditions
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Reliability - The consistency and likelihood of delivering positive returns during a market crisis
Correlations of alternative asset classes
Source: Morningstar 30/11/2014 to 30/11/2024
Crisis alpha, or long volatility exposure, often sits at the top of investors’ wish lists when it comes to alternatives. The appeal is clear: having an asset that is consistently negatively correlated with equities and bonds and can provide a dependable payoff during market crises. A prime example is the Amundi VIX ETF, which delivered an extraordinary 348% return during the COVID-19 market meltdown (February to March 2020). The issue with being negatively correlated to equities, is that equities tend to trend up over time. Therefore, assets designed to be negatively correlated to them tend to decline over the cycle. That same Amundi VIX ETF, for instance, has lost a staggering 92.5% of its value since its peak during COVID-19. Hedge funds offering tail risk protection and aim to mitigate the bleed face similar headwinds. For example, the Eureka Tail Risk Hedge Fund Index has shed 23% over the past decade, with a volatility of 14%
Eurekahedge Tail Risk Hedge Fund Index
Past performance does not predict future returns.
Morningstar: Dec 2007 to Sept 2024
The inherent premium bleed associated with long volatility crisis alpha instruments, such as options, underscores the importance of an investor’s entry and timing points. However, I place a very low likelihood on my ability to accurately predict the timing of the next market crisis. As a result, while options score highly on Reactivity (delivering substantial returns during crises) and Reliability (consistently responding to volatility spikes), they perform very poorly on Carry (negative returns in normal markets). Moreover, from a commercial perspective, private clients generally find investments with this type of return profile unappealing.
The ideal investment, often referred to as the "holy grail," is one with dynamic correlation—assets that are negatively correlated with equities during a crisis but uncorrelated during normal markets, avoiding a drag on performance over the cycle. Gold fits this description well. Historically it’s been uncorrelated to equities whilst tracking inflation over time but becomes negatively correlated in a crisis. That said, gold’s unpredictability presents a challenge. While I have a high degree of confidence it will perform in a crisis, the magnitude of its return is highly variable. This uncertainty complicates portfolio construction, as it’s difficult to estimate the "payout" from this insurance policy.
Gold Performance during stock market crashes
Past performance does not predict future returns.
Source: Morningstar: 21/09/1976 to 23/03/2020. Solactive US Large Cap
Beyond its performance in traditional crises, gold offers a unique form of tail risk protection—hedging against a potential collapse of the fiat monetary system. The probability of such an extreme scenario has increased in recent years, driven by the U.S. national debt reaching $36 trillion and, closer to home, the Labour Party loosening borrowing rules.
Yet, gold’s place in my investment framework remains complex. It does not provide yield, though it has historically tracked inflation. Owning gold today means forgoing the 4–5% return from short-dated gilts, which reduces its appeal on a carry basis. On reliability, gold generally delivers positive returns in crises, but its reactivity—how much it pays out—varies significantly. That’s before we even start the debate on how you would accurately value gold.
Trend-following hedge funds also exhibit the dynamic correlation I’m seeking. These strategies have a zero correlation to equities and bonds over the cycle but tend to be positively correlated in rising markets and negatively correlated in falling ones. This unique quality makes trend-following one of the few strategies capable of generating returns in both up and down markets. However, it’s no free lunch—trend strategies can struggle in range-bound, whipsawing markets where trends fail to materialise. For investors who have reduced their exposure to commodity-producing companies in recent years due to ESG considerations, trend-following strategies offer an excellent alternative to gain exposure to the diversification benefits of commodities within a 60/40 portfolio. It's important to acknowledge that trend-following strategies can endure prolonged periods of underperformance. The 2010s were particularly challenging, as the "Fed Put" led to fewer sustained trends and more frequent reversals. However, the current environment of higher interest rates and diminished central bank intervention could create favourable conditions for trend-following strategies to thrive again.
Trend strategies score well across the board on Reactivity, Reliability, and Carry. They have a long history of performing well in sustained market drawdowns (reactivity and reliability). They can also perform well in up markets (carry). Additionally, futures in trend funds are traded on margin, meaning the cash invested in these funds typically earns the prevailing cash rate. This minimises the opportunity cost compared to holding short-dated gilts, further enhancing their carry profile. Theres commercial aspect to consider when buying a trend fund. End clients tend to think of them as a ‘black box’, fees can be high, and they can experience drawdowns alongside equities if markets reverse sharply and unexpectedly.
Protection from Trend strategies in sustained drawdowns
Past performance does not predict future returns.
Source: Morningstar Dec 2006 to Mar 2009
This may not be a popular opinion, but several widely favoured "uncorrelated return" assets fall short of what I expect my alternatives allocation to deliver. Traditional go-to assets such as property, infrastructure, and renewables exhibit significant interest rate sensitivity. Additionally, the premium/discount dynamics of the associated investment trusts introduce an extra layer of volatility during crises. These assets are essentially long-duration plays on real yields with embedded credit beta and an illiquidity premium.
Similarly, private credit and private equity, in my view, do not belong in the alternatives bucket. Their name is a bit of a giveaway, they are extensions of the "credit" and "equity" components of a portfolio. While I see value in including these assets for clients with long time horizons to capture the illiquidity premium, their returns are derived from the same sources as traditional bonds and equities—interest rates, inflation, and global GDP growth—rather than alternative return streams.
I am also sceptical of "long-only multi-asset absolute return funds" that allocate across equities, bonds, and alternatives, even when managed by highly skilled investment teams. These funds often resemble diluted versions of a 60/40 portfolio, exhibiting high correlation to the broader portfolio and offering limited diversification benefits.
For truly uncorrelated returns, one often has to turn to the hedge fund industry. I can already imagine some readers shuddering at this notion—an industry that has, for the most part, “overpromised and underdelivered” all while charging hefty fees. The real problem, however, isn’t the hedge fund industry itself but rather the limited offering available in the UCITS space. Over the past 20 years, the UCITS hedge fund universe has significantly underperformed the broader global hedge fund industry. Why? The structural constraints of the UCITS wrapper often hinder high Sharpe ratio strategies from replicating their success.
UCITS vs Non UCITS HF Performance
Past performance does not predict future returns.
Source: Morningstar 31/12/2005 to 30/09/2024
If I’m committed to incorporating hedge funds into the portfolio, the real challenge lies in identifying which type of hedge fund can reliably deliver uncorrelated returns. Focusing on a single strategy can feel like a gamble, as certain funds may experience prolonged periods of underperformance when the macro environment doesn’t align with their approach. Practically, in a private client portfolio, I don’t have the space to allocate across 5–10 different strategies to achieve proper diversification —not to mention the time required to conduct thorough due diligence on such a large number of funds. Outsourcing this to a fund of funds introduces its own issues, such as layering of fees and over-diversification, with managers potentially running conflicting positions. Multi-strategy funds mitigate this by using internal strategies, but this can also narrow their opportunity set.
Ironically, if I’m seeking exposure to truly alternative sources of return, equity long/short strategies may be a good option. Long/short strategies tap into a unique source of return known as S, which is not captured in traditional 60/40 portfolios. Dispersion is the difference between winners and losers in the market, and it tends to increase in environments with higher interest rates and inflation. In the low-rate, low-inflation era, both strong and poor companies can perform well, but fluctuating inflation and policy uncertainty can drive greater dispersion. This environment should be more conducive to long/short strategies.
Like trend-following funds, most hedge funds—including long/short—are structured so that a £1 invested should deliver the prevailing cash rate plus the strategy’s returns. This means there is little opportunity cost compared to holding cash. Against my scorecard, long/short strategies score well on reliability and carry during normal markets, offering cash-plus returns in a fairly reliable manner. However, reactivity is where they often fall short. Many long/short strategies operate with a strategic long bias to take advantage of equities’ upward drift over time, but this leaves them vulnerable during crises. For example, the Eurekahedge Long/Short Equity Index has a 0.92 correlation and a 0.47 beta with global equity markets. Interestingly the correlations and beta of certain other strategies was much higher than I had expected. Higher sharpe strategies have also had higher equity correlations and beta.
Past performance does not predict future returns
Source: *Solactive DM Large & Mid Cap TR as equity benchmark. 01/11/2014 to 31/10/2024
Finding the right tools within the UCITS space to meet my three objectives while remaining commercially viable for clients is undeniably challenging. Throughout my career, I’ve rarely encountered investors who feel genuinely satisfied with their alternatives allocation. It was often the part of my portfolio where I had the least conviction, and unsurprisingly a constant target for client criticism. For now, I’ve opted for a mix of gold, trend-following, and a multi-strategy hedge fund—imperfect solutions that nonetheless offer the best balance I can achieve given available options.
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Crisis Alpha
Gold, while historically effective during crises, is unpredictable and heavily influenced by real yields. Its lack of intrinsic value makes it difficult to assess, leaving me reliant on the hope that human will continue to believe it is a store of value
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Sustained Drawdowns
Trend-following strategies, although effective in sustained drawdowns, come with high volatility and can struggle in choppy, whipsawing markets. Trend also seems to be like a red flag to a bull for many clients.
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Long Term Diversification
For uncorrelated returns, a multi-strategy fund appears to be the most suitable option, particularly one that incorporates equity long/short strategies to capture dispersion and is managed to maintain a low correlation with equities and bonds.
At Atlantic House, we are fortunate to have a fund specifically designed to address these three objectives: our Uncorrelated Strategies Fund. This fund aims to deliver cash-plus returns during normal markets and substantial positive returns during periods of market stress. It achieves this through three carefully constructed sleeves:
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Tail: Long volatility option positions, structured to minimize premium bleed.
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Trend: A blend of trend strategies designed to protect during sustained drawdowns.
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Diversifiers: Systematic strategies with return sources that are uncorrelated to equities and bonds.
This fund serves as a comprehensive, one-stop solution for the exposures many investors seek from their alternatives allocation. Most importantly, it is managed to maintain a low correlation to equity and bond markets. The Fund is competitively priced amongst its peers and all of the strategies can operate effectively within a UCITs framework.
Against my scorecard:
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The Tail sleeve, through options, provides measurable reactivity by offering defined payouts in a crisis. Its contractual nature ensures reliability, as it pays off under specific market events.
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The Diversifiers sleeve focuses on delivering consistent returns during normal market conditions, addressing the carry objective.
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Importantly, switching from short-dated gilts to this fund involves minimal opportunity cost. The fund invests £1 in short-dated T-bills, which currently generate around 30 basis points per month at the fund level.
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Commercially, having your trend exposure within a fund can help diversify periods of weaker returns and hopefully avoid some of those difficult client conversations.
The price of shares and income from them can go down as well as up and past performance is not a guide to future performance. Investors may not get back the full amount originally invested. The level and basis of tax is subject to change and will depend on individual circumstances. There is no guarantee that the Fund will achieve its objective.
A comprehensive list of risk factors is detailed in the Risk Factors Section of the Prospectus and the Supplement of the Fund and in the relevant key investor information document (KIID). A copy of the English version of the Supplement, the Prospectus, and any other offering document and the KIID can be viewed at www.atlantichousegroup.com and www.geminicapital.ie. A summary of investor rights associated with an investment in the Fund is available in English at www.gemincapital.ie.
The Fund is entitled to use derivative instruments for investment purposes and for efficient portfolio management and/ or to protect against exchange risks. Derivatives may not achieve their intended purpose. Their prices may move up or down significantly over relatively short periods of time which may result in losses greater than the amount paid. This could adversely impact the value of the Fund. The Fund may enter into various financial contracts (derivatives) with another party. Where the Fund uses futures or forward foreign currency contracts (derivatives), it may become exposed to certain investment risks including leverage, market, mismatching of exposure and/or counterparty risk, liquidity, interest rate, credit and management risks and the risk of improper valuation. Any movement in the price of these investments can have a significant impact on the value of the Fund and the Fund could lose more than the amount invested.
The Fund invests in government bonds. All bonds will be investment grade (i.e. at or above S&P rating BBB- or deemed equivalent). If any of the bonds the Fund owns suffer credit events the performance of the Fund could be adversely affected
In certain market conditions some assets in the Fund may become less liquid than at other times so selling at their true value and in a timely manner could become more difficult.
Other risks the Fund is exposed to include but are not limited to are possible changes in interest rates, changing expectations of future market volatility. Future legal or regulatory change could have a significant effect on the Fund.
This is a marketing communication issued by Atlantic House Investments Limited and does not constitute or form part of any offer or invitation to buy or sell shares. It should be read in conjunction with the Fund’s Prospectus, key investor information document (“KIID”) or offering memorandum. Atlantic House Investments Limited is authorised and regulated by the Financial Conduct Authority FRN 931264. Atlantic House Investments Limited is a Private Limited Company registered in England and Wales, registered number 11962808. Registered Office: One Eleven Edmund Street, Birmingham. B3 2HJ.
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The Atlantic House Dynamic Duration Fund is a sub-fund of GemCap Investment Funds (Ireland) plc, an umbrella type open-ended investment company with variable capital, incorporated on 1 June 2010 with limited liability under the laws of Ireland with segregated liability between sub-funds.
GemCap Investment Funds (Ireland) plc is authorised in Ireland by the Central Bank of Ireland pursuant to the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011 (S.I. No. 352 of 2011) (the “UCITS Regulations”), as amended.
Gemini Capital Management (Ireland) Limited, trading as GemCap, is a limited liability company registered under the registered number 579677 under Irish law pursuant to the Companies Act 2014 which is regulated by the Central Bank of Ireland. Its principal office is at Suites 22-26 Morrison Chambers, 32 Nassau Street, Dublin 2, D02 X598 and its registered office is at 7th Floor, Block A, One Park Place, Upper Hatch Street, Dublin 2, D02E762. GemCap acts as both management company and global distributor to GemCap Investment Funds (Ireland) plc
