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Does it make sense of riskier exposures in times of high volatility and negativism

With the US stock market falling by more than 7% and the bond market by almost 9% so far this year, many investors believe they need to take more risk to catch up.

A global survey of nearly 300 professional investors from BofA Global Research found in March that the percentage of fund managers with higher-than-average US equity exposures rose 27 percentage points from February.

“Alternatives” such as private equity, private debt, hedge funds and non-traded real estate have become so fashionable that investors are taking advantage of low interest rates to invest in them.
One of the most popular ways of such an investment is through unlisted closed-end funds, portfolios of alternative assets that are registered with the Securities and Exchange Commission but are not traded on an exchange.

Investors are usually unable to withdraw their money whenever they want, as they can in traditional mutual funds or exchange traded funds. Instead, they can only sell at a predetermined time, often four times a year, sometimes only twice.

Management costs often exceed 1.5% per year. Such funds managed a total of $ 93.7 billion at the end of 2021, compared to $ 54 billion in 2018, according to Patrick Newcomb, director of the Fuse Research Network in Needham, Massachusetts.
The days of fame for approaches like these are probably over, says Anti Ilmanen, an investment strategist at AQR Capital Management in Greenwich, Connecticut.

As many assets are still close to all-time highs, future returns are likely to be lower, Mr Ilmanen said.

Let’s imagine we own a bond. To keep things as simple as possible, we imagine a simple $ 1,000 bond that pays 3% per year for 10 years. If we buy it for $ 1,000 with an annual interest rate of $ 30, it will bring us a 3% return. However, if we pay $ 1,200 for the same bond, our return of $ 30 will be 2.5%.

To make an overall assessment of how expensive the shares are, Mr Ilmanen used a modified version of a measure developed by economist Robert Schiller of Yale University. Mr Ilmanen’s mathematics shows that US stock markets could recover by less than 3% a year after inflation for the next five or more years.

What can we do?

We must avoid pursuing illiquid assets – some of which, such as private equity, are no longer clearly cheap compared to publicly traded stocks, Mr Ilmanen’s study shows.

We need to look outside the United States, where stock markets are significantly cheaper.

First of all, we should not take greater risks in an attempt to catch up. Risky holdings, such as unmarked stocks and bonds, have seemed secure in bullish markets over the past decade. But they could provide a “bad return in bad times” that is not so fleeting in early 2020, Mr Ilmanen said.


 Dealer Anatoliy Pavlov

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