Trends Watch: March 1, 2018

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks to Faryan Amir-Ghassemi, Founder, Epsilon Asset Management.

What’s your outlook for alternatives?

Alternatives are at a moment of truth.  In an extended bull market whose hallmark has been the infallibility of passive beta, almost any active-oriented decision (tail-risk hedging, exposure management, contrarian positioning, value-orientation) has been punished.  This levies a psychological toll not only on managers who have underperformed, but on institutional allocators who must answer to their constituents.  It is precisely at the time of peak duress when clear reasoning is required.  If (and a big if) we are at such a moment, alternatives must reinforce their value proposition by demonstrating an ability to adapt to turbulent markets, to avoid the trap of latent tail risks, and to take asymmetric or uncorrelated bets.  Alternatives cannot be caught flat-footed like we’ve seen in many of the market hiccups through this cycle.  If alternatives deliver, institutional investors who hung in will have renewed faith.  If not, expect more disintermediation and an emphasis towards simplification of institutional portfolios.

What is your outlook for the economy?

We are not macroeconomists, nor do we incorporate top-down views in our investment process.  But if we had to reflect on the current environment, we would balance the relative robustness of incoming economic data with base-case probabilities evinced through history.  The latter would include the length, breadth, and sustainability of expansionary economic cycles; the resilience of sovereign balance sheets to exogenous shock after extended disrepair; and the nature of mispriced risk in financial markets (traditional and shadow).  When using these competing lenses, the economy may appear healthy in the breadth and nature of evolving macro data, while simultaneously vulnerable through its depleted monetary capacity, leaky balance sheets, and political fragmentation.  Surely not a satisfying answer, but the question is vexing us at present.

What keeps you up at night?

The nature of tail-risk, and how that risk metastasizes in unpredictable fashion.  Tail risks are particularly nasty when distortions cause investor behavior to adapt, and we’re coming to the end of an unprecedented experiment in the form of extraordinary easing of monetary policy.  Case in point: the embedded duration of global fixed income, the extension of equity valuations from historical norms, and the stubbornness of ephemeral inflation.  Empirically, post-crisis monetary policy has been wildly successful, preventing a deep financial recession from causing generational damage to the real economy.  But the inevitable consequences of policy normalization will show in unexpected ways.  We had a taste of this with this recent unwind of mispriced risk allocated toward a short volatility “carry trade.”  While investors were largely in agreement that the volatility regime witnessed in 2017 was abnormally suppressed, its ultimate reversal gashed markets in predictably unpredictable fashion.  We ask: What is the next unwind, and will it have a severe transmission effect into the real economy?