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Alternatives: A Traditional Fixed Income Replacement As 2017 begins, a time to reconsider?

As 2016 becomes less visible in the rear view mirror, investors are once again compelled to look forward as they construct durable portfolios. While markets may look uncertain to many sage investors, there have been some key uncertainties removed from the market including the US presidential election, crashing oil prices, Fed-direction uncertainty, and the positive/negative sign on global growth. Very significantly, one key driver of portfolios, global bond returns, appears to have come to the end of a 35-year bull run. The professional allocator is thus faced with the usual conundrum of how to position the portfolio differently, if at all, in 2017 and beyond plus the fiduciary pressure to replace bond exposure with another asset class. Despite the press widely reporting on the death or at least new paradigm of the hedge fund, it is again worth considering adding a lower-volatility, well-diversified hedge fund exposure to make up the gap left by traditional, long-only fixed income returns.

Traditional fixed income assets, particularly ratesensitive ones, have had a decades long, mostly low volatility bull run that has provided a steady income source for many traditional (70% bond/30% equity, 60%/40%) institutional portfolios with mid to long range outlooks. Coupon income was reliable and maturities were easily replaced with a selection of global bonds with coupons high enough to get the portfolios well on the way to achieving their bogey rate of return. Some of the decline in yields has been offset by institutions with the addition of leverage, which obviously has not been without periods of peril. The volatility has largely been episodic, with the last big spike being the US Treasuries flash crash of 15 October 2015 prior to the more recent rate rise. The current rate rise is largely attributed to a gradual tightening of monetary policy coupled with the perceived coming fiscal policy changes of the new US Administration, led by unexpected victor Donald Trump. Regardless of impetus attribution, it does appear that the global bull market in bonds has now been supplanted by a bear market or at least a trading market. The following chart of US yields shows that this trend, which was ultimately relied upon by both discretionary and systematic managers is finally exhausted.

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