Implementing absolute return in a multi-asset framework

Institutions face challenges in a low-return market environment frequently interrupted with phases of high volatility. Many are seeking to improve portfolio risk-adjusted returns (Sharpe ratio) without sacrificing return objectives. Logically, two approaches are possible: pursuing a portfolio’s required rate of return with less volatility, or seeking to increase returns without a significant boost in volatility. Many institutions have made progress towards these goals by expanding the range of asset classes in which they invest, going beyond a split, or 60/40 equity and fixed income balance, whilst also refining the optimal mix of assets.

We believe including absolute return strategies may hold greater promise for improving an institutional pension scheme’s portfolio efficiency. We define absolute return strategies as unconstrained, benchmark-agnostic approaches that focus on more efficient returns with less systematic risk (beta).

Survey data indicate, however, that many schemes continue to rely on expanding the range of traditional asset classes as a solution. Mercer’s 2014 European Asset Allocation Survey of over 1,200 plans from 14 European countries shows that, even as institutions seek to reduce their reliance on equities within their home countries, multi-asset schemes are inclined to favor adding high yield, real estate, emerging markets (EM) equity and EM debt, along with other types of credit risk.

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