Investors should be interested to know that the average age of the planet’s population is increasing by six hours every 90 days or so. Reality is, living longer is not free. In developed economies, it usually means more years in retirement and, as a result, a growing attraction to assets that generate low volatility returns for longer periods of time. There are clear implications for how economies, markets and – in turn – asset allocations will adapt. It is highly likely that hedge funds will play an increasingly important role in providing better diversification with greater liquidity when compared against other alternative investments such as private equity, infrastructure or real estate.
The October 2014 International Monetary Fund (IMF) report downgraded growth for most economies. But the current economic outlook for the US is substantially stronger than the rest of the developed market economies, reflected in the fact that the IMF report also upgraded US growth projections by 50 basis points to 2.2 percent (year over year) in 2014 and 3.1 percent in 2015.
Based on this improved economic outlook and stimulative factors such as low interest rates and low gasoline prices, it is unlikely that poor growth in other developed economies will bring down US growth by very much. It is possible, the resultant lower interest rates and gasoline price will more than make up for the drag from potentially lower exports or a stronger dollar. This could have a similarly stimulative effect on the US’s trading partners’ economies, especially those that import a significant percent of their petroleum products.
Conventional wisdom suggests that, as investors age, they allocate a greater portion of their portfolio to fixed income assets as, historically, they deliver a more predictable lower return stream with much lower volatility than other types of investments.
People living longer will also start looking for greater return and low volatility. While modern portfolio theory has come under fire since the global financial crisis, it does suggest that diversification of different assets that perform differently from each other can help investors weather minor market storms and can improve compounding by reducing drawdowns in portfolio assets.
An aging population experiencing greater longevity will – by increasing its allocation to bonds – push down yields, reducing returns which creates demand for a wider variety of assets to help diversify portfolios in an attempt to reduce volatility and improve compounded returns.
This need for diversification is likely to continue to drive allocations to alternative investments and hedge funds are an important part of that alternatives universe. They can be used to increase allocations to fixed income without taking duration risk; they can be used to gain exposure to commodities that are not constrained by the near contract rolls that exchange-traded funds (ETFs) are subject to; and they can provide almost every stripe of exposure to equities on both the long and short side.
In a recent study by Cerulli, 72 percent of respondents cited the need to optimize risk adjusted returns as the primary reason for increasing their allocation to alternative assets. Given the current global economic outlook and the trend towards increased longevity, it seems clear that diversifying portfolio allocation still has more time to run its course and hedge funds will be a primary beneficiary.