Investors must look beyond hedge funds and private equity in their quest for uncorrelated returns, according to Marc Syz, co-founder and managing partner at Syz Capital, who believes niche assets – such as litigation finance and life settlements – can offer investors improved portfolio diversification.
Investors must look beyond hedge funds and private equity in their quest for uncorrelated returns, according to Marc Syz (pictured), co-founder and managing partner at Syz Capital, who believes niche assets – such as litigation finance and life settlements – can offer investors improved portfolio diversification.
Syz said the ongoing Covid-19 pandemic has “plunged us into a situation of ongoing uncertainty”, in turn fueling investor demand for uncorrelated assets to help stave off volatility.
“Correlations are rising between fixed income and equities, stock prices look overheated, and fixed income investors are beginning to protect themselves against the potential of further spikes in inflation,” he observed in a market commentary this week.
“Against a backdrop warped by mass global stimulus, investors are naturally pivoting to what they believe are uncorrelated solutions on an unprecedented scale.”
But he warned it is now becoming increasingly necessary for investors to search beyond the typical hedge fund and private equity products to generate uncorrelated returns in their portfolios.
“Certain hedge fund, market neutral and risk parity strategies call themselves ‘uncorrelated’, but in the case of an exogenous shock, such as the Covid-19 pandemic, or the Greensill Capital collapse earlier this year, the majority of these assets also suffered – albeit to a lesser degree.”
Established by Marc Syz in 2018, Syz Capital aims to provide private clients exposure to hard-to-access, niche investments often reserved to institutional allocators, spanning hedge funds, direct private equity, special situations, uncorrelated strategies. The alternatives-focused firm manages more than CHF1.5 billion (USD1.63 billion) in assets across a range of liquid and illiquid alternatives.
In the note, Syz pointed to assets such as litigation finance, royalties, and life settlements, which he said offer allocators little to no correlation to broader market or macro movements.
Music or pharmaceutical royalties, for instance, face risks stemming from changing music tastes or demand for drugs, rather than market volatility, while litigation finance returns hinge on a broad set of case-by-case idiosyncratic factors – the size and type of action, and the resources of the defendant and claimant, for instance.
As more mainstream investors and pension funds pile into alternatives, certain uncorrelated strategies will see more take-up from the mainstream.
“While it will become harder for uncorrelated strategies to produce high risk-adjusted returns with more capital competing for the same products, there remains an enormous advantage to investing in uncorrelated assets from a risk diversification perspective.”
However, he also cautioned that many investors often “confuse correlation with risk”, noting that while uncorrelated assets are not exposed to broader market or macro volatility, and are “resistant to exogenous shocks and market cyclicality”, they are not immune to other types of risk.
“Holding too many of the same uncorrelated assets can also concentrate risk,” Syz said. “Only by constructing a diversified portfolio, which contains a balance of traditional and uncorrelated asset classes, can investors truly reduce risk.”
He added: “Uncorrelated assets – to different degrees – are a useful tool for portfolio diversification, but to unearth truly uncorrelated returns, which are immune to market turbulence, investors need to be prepared to dig deeper into niche alternative investments, while remaining nimble and flexible.”