April 2020 | Posted By Scott Krajacic

We like to share updates from our Investment Policy Committee, which makes key decisions involving the specific evidence-based tools and funds we use to execute our approach. The following is a note they wanted to share for our readers:

The year has been off to a rocky start – with global equity markets roiling from the coronavirus pandemic, and volatility remaining elevated above historic levels. When rough markets come, our clients are ready. How? Uncorrelated asset classes. One of the ways we help combat the inevitable ups-and-downs are by including certain asset classes in clients’ portfolios that move differently from equity markets.

The most familiar of these is fixed income. Most people know intuitively that investing in fixed income reduces risk exposure, as we saw most recently during the 2008 financial crisis. We are a firm believer that while equities help you “eat well,” fixed income helps you “sleep well.” In other words, equities are the source of your return, and fixed income is your stability. That’s why we believe in holding high quality bonds with short to intermediate maturities – solid and sturdy.

Fixed income is the way most of us are  familiar with capturing this benefit. At HIG we go a couple of steps further – capturing other uncorrelated asset classes through market neutral funds. Market neutral funds do basically what their name says – they seek to access return no matter what is happening in the market. They do this by targeting sources of return unrelated (and therefore uncorrelated) to the traditional equity and fixed income markets.

We believe incorporating the right market neutral fund can help smooth the ride, while maximizing your odds of success – making it easier for you to stick with your allocation when things get rough. An added benefit? Market neutral funds can allow you to capture a higher expected return than fixed income – a win-win in our book.

Just like with all things, not all market neutral funds are created equal. The market neutral fund we recommend is the Style Premia Alternative fund (QSPIX), created by AQR.  With this fund, AQR takes a disciplined and systematic approach that aligns itself with our evidence-based investment philosophy. The fund invests across five different asset types and four investment styles, that over the long-term have shown very low correlation to the equity markets.

Here’s some hard data to illustrate the point: since the markets peaked on February 19th this year, the S&P 500 has dropped by 23.3% while AQR’s Style Premia Alternative fund has shown a decline of only 7.5% through the end of March. Although diversification is not meant to eliminate risk completely (which would mean no reward on the other side) it can reduce the extreme highs and lows, offering a smoother ride to help our clients take the long view.