Many investors came into 2022 with their eyes wide open. Elevated equity valuations, waning policy support and higher interest rates suggested that it was probably time to start thinking about some strategy changes. Since then, geopolitical unrest has only confirmed the need to reassess expectations and asset allocations.
And when it comes to change, evidence suggests investor minds are open, too. As core equities and fixed income have struggled year-to-date, alternative mutual funds have recorded net inflows of more than $11.6 billion1. Also known as liquid alternatives, these funds often have characteristics similar to hedge funds but are public vehicles that can be traded easily. Many offer investors a higher degree of diversity and flexibility, such as the ability to take long and short views on specific assets, and have few or no ties to traditional benchmarks.
But despite the recent inflow, a review of 9,500 professionally managed portfolios using our proprietary GS PRISM™ portfolio analysis tool found that the average allocation held by financial advisors in recent years was just 3.8%. Moreover, the majority of advisors in 2021—62%—hold nearly no allocation (less than 1%)2.
We think there is a case to be made for increasing those allocations. The way we see it, liquid alternatives offer two potential advantages.
First, we believe they may reduce the effects of severe equity drawdowns.
Since 1990, during periods where the S&P 500 Index fell 15% or more from its peak, diversified liquid alternatives outperformed US large cap equities by between 13 and 47 percentage points (pp). Exposure to these assets during volatile market environments may help investors avoid emotional selling, maintain a long-term investment perspective, and participate in subsequent rebounds.
