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Replacing fixed income with equity market-neutral – a dangerous idea

Some investors replace part of their fixed income holdings with market-neutral equity. Though these funds are supposedly uncorrelated to the equity market, it’s better to choose a diversified approach, argues Rui Machado, alternative investments director at IM gestao de ativos in Lisbon.


PA Europe

“There is not a lot of money to make in fixed income, so understandably investors want to replace it with something else,” says Machado.

But it would be unwise to switch all this money to market-neutral equity funds, because that fundamentally would change the risk profile of a portfolio, he argues.

“If the equity market is down by, say 20%, you really can’t be sure an equity market-neutral manager will outperform or underperform. It’s a totally different sort of risk you are taking.”

Diversification is key

Investors should instead opt for a diversified absolute return allocation, according to Machado.

“We look at combining single strategies within absolute return. A portfolio with a lot of different alternative building blocks, like market-neutral, long/short, credit, global macro, multi-manager and multi-strategy funds, is the real diversifier and alpha generator. Investing in one specific strategy would be mistake,” he says.

With this diversified approach, Machado would even be comfortable swapping all his bonds for absolute return investments. “You can even put 100% of your bonds into absoltue return if you just do it the right way,” Machado concludes.