Truly uncorrelated returns are difficult to unearth, but they can change the look of one’s portfolio, says Marc Syz, the managing director of Syz Capital
Covid-19 plunged the world into a new era of uncertainty, driving up demand for uncorrelated assets as investors sought to mitigate market volatility.
Now, as the market absorbs the supply-chain squeeze, the impact on interest rates and inflation hangs in the balance. Against such a challenging backdrop, emerging asset classes producing uncorrelated returns may seem attractive.
Unearthing truly uncorrelated returns on listed markets is difficult — despite the flurry of solutions claiming their uncorrelated credentials. It is necessary to go further than your typical hedge funds or private equity solutions to find what I would describe as ‘true’ uncorrelated assets.
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Litigation finance is an emerging asset class that bears no correlation to market or macro movements. Providing upfront funding for a litigation claim in return for a share of the settlement can be a good route to returns. The outcome of the case and, hence, the return expectations are dependent on a number of idiosyncratic factors – such as the type of the defendant, the type of case and the jurisdiction.
Royalties — whether pharmaceutical or music royalties — are rapidly emerging as an attractive way to reap recurring revenues from intellectual property rights. While these also bear different types of risk – related to changing music tastes or demand for drugs — the returns are entirely divorced from market volatility. Since many of these asset classes are still in their infancy, opportunities for deploying capital remain limited. However, as alternatives witness more take-up from mainstream investors and pension funds, some of these uncorrelated strategies will make it into 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.
In addition, there will always be new opportunities for high risk-adjusted returns emerging elsewhere, which smaller, nimbler strategies will be able to access. For this reason, we set limits on the sizes of our strategies, to ensure our investors are first in line for achieving high uncorrelated returns.
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As investors continue to reach for protection in times of uncertainty, it is crucial they understand the nuances behind uncorrelated returns. Uncorrelated assets can be 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 a little deeper.
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