Intergalactic stars: Navigating beyond beta

The above idea feels especially relevant today. Equities have delivered strong returns, but often at the expense of concentrated exposures and elevated valuations. Bonds, meanwhile, now offer higher yields, but have at times moved in tandem with equities, limiting their role as a diversifier.

Private markets are gaining traction as a source of additional return potential. The idea is that by accepting some illiquidity, investors can seek to access return streams shaped by long-term structural drivers.

However, some strategies remain underutilised; not because they lack merit, but because they’re often misunderstood. Insurance-linked securities (cat bonds) and alternative risk premia (ARP) fall into this camp. They’re sometimes framed as complex or niche, when in fact they can offer clean, scalable ways to broaden the investment universe. 

In the Asset Allocation team we seek to access these often overlooked asset classes in ways that are straightforward, efficient, and considered, seeking to broaden the opportunity set for our clients and strengthen diversification.

Cat bonds: Uncorrelated by nature

Cat bonds are unusual in that their returns are tied to physical events, like hurricanes or earthquakes, rather than economic cycles. This makes them one of the few assets that can provide meaningful diversification. While not immune to broader risk-off sentiment, their return drivers are distinct enough to offer potential resilience when traditional assets falter.

As explored in our blog Cat bonds: worth a fresh look, these instruments offer a rare combination of yield and uncorrelated return potential – qualities that are increasingly valuable in today’s market environment.

Despite issuance nearing $23 billion last year, cat bonds remain underrepresented in portfolios, often because they are assumed to be technical or niche. But at their core, cat bonds are conceptually straightforward: investors assume insurance risk in exchange for a yield that’s largely uncorrelated with traditional assets.

We access this asset class by holding the bonds directly – an approach that manages costs while allowing us to carry out focused due diligence and integrate exposures in a way that’s both efficient and deliberate. Our focus isn’t on trying to outperform other cat bond market participants, but on building exposure that reflects the broader market and delivers resilient, diversifying returns.

We focus on cat bond segments where risks are well understood and transparently modelled, avoiding esoteric exposures like cybersecurity or complex structures such as sidecars. We also target specific perils and regions that have the potential to offer attractive compensation, as they are in areas where the wider market is already heavily exposed, creating opportunities to access higher spreads relative to expected losses. 

Alternative Risk Premia: Rotating outside the risk cluster

Alternative risk premia strategies aim to capture structural return drivers—such as value, carry and trend—across asset classes. These are not fleeting anomalies, and are underpinned by behavioural biases and structural inefficiencies.

In our ARP philosophy we outlined how we believe ARP strategies should be simple, liquid, transparent, and diversifying. That’s why we develop and manage them in-house, using liquid instruments and a rules-based framework. This gives us full control over design, implementation and cost – thereby seeking to avoid the opacity and overheads that can come with outsourced or over-engineered solutions.

Our pragmatic, modular approach allows us to net offsetting positions, manage costs, and maintain transparency. Each strategy has a clear rationale – exploiting yield curve slopes, commodity convexity, or carry and value in FX. 

We manage ARP as a portfolio, not just a collection of strategies. Our tools allow us to monitor co-behaviours, manage aggregate risk, and avoid unintended concentrations -crucial in a world where correlations can shift rapidly.

The result is a set of strategies that are liquid, scalable, and genuinely diversifying. They’re designed to sit outside the traditional risk clusters – offering exposure that’s distinct from conventional market drivers and valuable in portfolio construction.

Locating the intergalactic stars of diversification

Seven years ago we first introduced our correlation galaxy framework in our blog Correlation galaxies – how to grasp asset class behaviour over time. It was designed to make sense of complex correlation matrices by mapping asset classes based on how closely they move together. Those with high correlation cluster near each other, while those with low correlation sit further apart.

The framework remains a powerful way to visualise diversification. This version uses 20 years of data, offering a long-term view of asset behaviour.

The chart highlights how cat bonds and ARP strategies sit outside the traditional clusters—appearing as ‘intergalactic stars’ in the investment universe. We believe that their distance from conventional market drivers helps to makes them valuable in portfolio construction.

From beta to better?

In a world where many assets move together, finding those that behave differently is increasingly valuable. Cat bonds and ARP sit on the edges of the investment universe, but that distance gives them strength. By including these 'intergalactic stars', investors can seek to build portfolios that are more resilient, more balanced, and better prepared for whatever lies ahead.

 

It should be noted that diversification is no guarantee against a loss in a declining market.