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Time to be selective in alternatives

4 minute read

12 November 2019

By Gerald Moser, London UK, Chief Market Strategist

With periods of heightened uncertainty likely again in 2020 as the global economy slows, gold may have a valuable role to play in diversifying portfolios, defensively.

Oil price set to be range-bound

The oil market is likely to be stuck in a tug of war between less supportive fundamentals and geopolitical events and tensions in the Middle East. The latter should be at least as prevalent as they were in 2019.

Turning to fundamentals, the key supply-side factor is likely to be the growth in shale oil output in the US, as well as non-Organisation of Petroleum Exporting Countries (OPEC) growth in general. Ongoing OPEC cuts are merely compensating for that non-OPEC growth.

On the demand side, the manufacturing slowdown affected oil demand more than the global growth environment would have suggested. Meanwhile, demand in 2020 will likely remain lacklustre. However, inventories declined in the second half of 2019 and the tense geopolitical environment is likely to keep adding a premium on the oil price throughout 2020. For this reason, we think that the oil price will stay in a wide range of around $60 per barrel in the next twelve months.

Gold starts to shine

One area of the commodity market we like is gold, as it plays a positive role in a portfolio context in the current environment. With uncertainty high and global growth slowing, gold adds defensiveness, and an uncorrelated return, in a diversified portfolio.

Furthermore, central banks’ demand for the precious metal continues to grow (see chart), especially in countries with a contentious relationship with the US. The confrontational international policy being conducted by the US is encouraging more countries to find alternative wealth savings to the US dollar. And gold is the main beneficiary of that diversification away from dollar reserves.

Central banks boost gold reserves

Private assets allocations improve a portfolio’s risk-return profile

Most assets, especially growth-driven assets such as equities, are likely to experience periods of heightened volatility in 2020, as additional risk premium is priced in during periods of stress. Illiquid assets focusing on fundamentals, rather than short-term risk aversion, should help improve the risk-return profile of a portfolio.

In addition, as we expect modest price returns at best across most public markets, collecting an illiquidity premium by investing in private assets helps to improve a portfolio’s overall returns. As always, manager selection is going to be more important than the strategy pursued.

Low-beta hedging strategies

In the hedge funds space, as highlighted in our “hedging and diversifying” investment theme, we like strategies with low beta and that are fundamentally driven, such as mergers arbitrage and, more broadly, market-neutral funds.

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