Allocating to Hybrid Alternative Strategies: A Path to More Than Just Weathering the Storm

A hybrid alternative strategy (or simply, hybrid strategy) combines alternative and traditional investment strategies within one product wrapper. Many alternative strategies are defense-only, helping portfolios weather the storm but often contributing little otherwise. Hybrid strategies play both offense and defense and have the potential to contribute to an overall portfolio in various market environments.

Chart 1: Growth of $100. Outperformance of Hybrid Strategy’s Offense + Defense Approach

Data Source: Bloomberg LP and Catalyst Capital Advisors LLC. Based on monthly return data from 12/31/1999 to 7/31/2024. Graph presented in logarithmic scale. 60%/40% Portfolio represented by 60% allocation to the S&P 500 TR Index (“S&P 500”) and 40% allocation to the Bloomberg Agg TR Index (“Agg”) rebalanced monthly. Hybrid Strategy represented by 100% notional exposure to SG CTA Trend Index, 60% allocation to the S&P 500 and a 40% allocation to the Bloomberg US Treasury TR Index (to represent collateral for futures program), rebalanced monthly. Past performance does not guarantee future results.

Chart 2: Risk Curve. Allocating to Hybrid Strategies Historically Reduced Risk Without Sacrificing Returns

Data Source: Bloomberg LP and Catalyst Capital Advisors LLC. Based on monthly return data from 12/31/1999 to 7/31/2024. Portfolio descriptions refer to % S&P / % Agg / % Hybrid Strategy described under the first graph, rebalanced monthly.

Many risk-averse investors reduce equity exposure and increase bond exposure when markets turn, leading to meaningful risk reduction at the expense of returns (see Chart 2). However, as the allocation to a hybrid strategy increases from 5% to 20% of a portfolio, the returns increased while volatility decreased (i.e., returns were enhanced).

Chart 3: Worst Drawdown. Allocating to Hybrid Strategies Historically Reduced Worst Drawdowns

Chart 4: Equity Bear Markets. Allocating to Hybrid Strategies Improved Bear Market Performance

Data Source: Bloomberg LP and Catalyst Capital Advisors LLC. Based on monthly return data. Portfolio descriptions refer to % S&P / % Agg / % Hybrid Strategy described under the first graph, rebalanced monthly.

Chart 3 demonstrates that a larger allocation to a hybrid strategy reduced the extent of a portfolio’s maximum drawdown (peak-to-trough loss). Chart 4 presents the returns during equity bear market periods since 1999. Investors could have reduced drawdowns by increasing their bond exposure or increasing their exposure to a hybrid strategy. However, as shown, the allocation to the hybrid strategy provided more protection.

Chart 5: Monthly Return Scatterplot. Hybrid Strategy Returns Were More Uncorrelated Than 60/40 Returns

Data Source: Bloomberg LP and Catalyst Capital Advisors LLC. Based on monthly return data from 12/31/1999 to 7/31/2024. Descriptions described under first graph.

Unlike the 60/40 approach, which is highly correlated to the S&P 500 TR Index, a hybrid strategy has the potential to provide more of an uncorrelated return stream, which is critical to long-term outperformance (Chart 4).

Chart 6: Growth of $100. The Challenges of Allocating to Defense-Only.

Data Source: Bloomberg LP and Catalyst Capital Advisors LLC. Based on monthly return data from 12/31/1999 to 7/31/2024.

When evaluating hybrid strategies, many potential investors will say something to the extent of, “Can’t I just allocate to a defensive strategy myself?”. Our response usually involves the following concerns:

Investor discipline. How certain are you that you will be able to withstand the very long periods of flat or negative years to reap the benefits that come during periods of turmoil (see Chart 6)?
Capital allocation. A dollar invested in a hybrid strategy is a dollar of alternative exposure and a dollar of traditional exposure.
Ease of allocation. In this paper, we used a hybrid strategy that included 60/40 exposure plus alternative exposure. In this case, the 60/40 exposure you would need to reduce to add to a hybrid strategy would simply get replaced by the hybrid strategy itself (i.e., you don’t lose anything you already had).

Summary:

Hybrid strategies offer a compelling way to integrate defensive exposure into your portfolio.
Historically, allocating to hybrid strategies has proven to provide more than just a path to weather the storm. It has enhanced returns, reduced volatility, minimized the extent of drawdowns, and reduced a portfolio’s correlation to equities.
The larger the allocation to a hybrid strategy, the better the long-term benefits for an overall portfolio.
Hybrid strategies are not short-term, tail-risk strategies. The defensive component is typically designed to perform well during structural bear markets or long-term adverse market conditions. A one-off bad month in the market may coincide with a bad month for the hybrid strategy (Chart 5). Evaluate hybrid strategies over the long-term.

Past performance is not a guarantee of future results. Diversification does not ensure a profit or guarantee against loss.

There is no assurance that any strategy will achieve its investment objective.

The use of derivatives and the resulting high portfolio turnover may expose investors to additional risks that they would not be subject to if it invested directly in the securities and commodities underlying those derivatives. A hybrid strategy may experience losses that exceed those experienced by strategies that do not use futures contracts, options and hedging strategies. Investing in the commodities markets may subject the hybrid strategy to greater volatility than investments in traditional securities. There are also risks associated with the sale and purchase of forward contracts.

Definitions:

Bloomberg US Aggregate Bond Index: A market capitalization-weighted index that is designed to measure the performance of the U.S. investment grade bond market with maturities of more than one year.

Bloomberg US Treasury Index: Measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury.

Diversification: A risk management strategy that creates a mix of various investments within a portfolio.

Futures: contracts to buy or sell a specific underlying asset at a future date.

S&P 500 Index: A market capitalization-weighted index that is used to represent the U.S. large-cap stock market.

SG CTA Trend Index: The SG CTA Trend Sub-Index is a subset of the SG CTA Index, and follows traders of trend following methodologies. The SG CTA Index is equal weighted, calculates the daily rate of return for a pool of CTAs selected from the larger managers that are open to new investment.

Volatility: A statistical measure of the dispersion of returns for a given security or market index.