The COVID-19 crisis is sharpening the appetite among investors in Europe for alternative investments as it has become clear that traditional assets cannot always be relied on for effective diversification, says the latest issue of The Cerulli Edge―Global Edition.

The markets’ sell-off in March, triggered by the coronavirus pandemic, saw expected correlation patterns disrupted. Global equities, corporate and government bonds, currencies, and oil all tumbled—their positive correlations threatening the diversification strategies put in place by asset managers. Cerulli notes that correlations remain relatively high.

To mitigate the impact, many managers of multi-asset funds have widened their exposure to alternative assets in order to maintain diversification.

“Cerulli expects that the appeal of alternatives that provide low correlations with mainstream assets—such as real estate, private equity, venture capital, hedge strategies, precious metals, infrastructure debt, and currencies—will continue to grow,” says Justina Deveikyte, associate director, European institutional research, at Cerulli.

“With assets continuing to display higher return correlations than is usual, there is a view that the traditional asset class relationships may have shifted in a more long-term sense. What was dubbed the ‘everything rally’ has made clear just how highly correlated asset classes, strategies, and markets have become, fueled by global monetary and fiscal stimulus,” Deveikyte adds.

Some alternative assets have been hit hard by pandemic-related volatility. However, the volatility of a truly diversified portfolio will be shaped by the overall correlation of the different assets, not by the volatility of the individual assets, says Cerulli.

Much depends on managers’ ability to blend assets with different risk drivers and risk-return characteristics in a way that derives benefit from their lower correlation with equities and bonds and produces genuine diversification.

But as Deveikyte points out, “This is easier said than done. Growing demand for alternatives creates its own problems, including higher valuations and longer-term issues such as high charges, poor liquidity, and concerns over transparency, which are still to be satisfactorily addressed.”

Other Findings:

• The huge amount of fiscal intervention in Europe in response to the impact of the COVID-19 lockdowns across the global is unlikely to result in a sharp and sustained increase in inflation as seen in the 1970s, says Cerulli. The global research and consulting firm believes that a return to “normal” inflation levels is more likely. Nevertheless, it has noticed a shift within Europe into inflation-linked bonds and real assets that will act as an effective inflation hedge in case a different scenario plays out.

• In Asia, efforts to build third-pillar pensions across the region present opportunities for target-date funds (TDFs) and target-risk funds (TRFs). In China, for example, asset managers are lining up their products strategically in anticipation of regulators bringing in further policies to develop third-pillar pensions. Such products include pension target funds or funds of funds using either the TDF strategy or TRF strategy.