Liquid Alternatives at Work

Liquid alternatives can improve portfolio resilience by combining diversification, daily liquidity, and dry powder for reallocations during market stress.

• Entering 2022, GMO’s Benchmark-Free Allocation Strategy held no Treasuries, less than 30% in stocks, and more than 60% in liquid alternatives because GMO judged stocks and bonds extremely expensive.
• As MSCI ACWI fell 18% and 10-year U.S. Treasury yields rose 236 basis points in 2022, the liquid-alternatives allocation delivered positive returns with low volatility.
• GMO used the alternatives allocation to buy 23 percentage points of stock and credit during the year as valuations became more attractive.
• The approach relies on limited equity-beta and duration exposure, positive returns from several sources, and daily liquidity to rotate into risk assets incrementally.
• GMO identifies potential future threats including an IPO lockup-related selling wave, an AI boom failing to meet growth and profit expectations, and persistent inflation pushing real rates higher; its Equity Dislocation, World Market Neutral, Long-Short Quality, and Global Macro strategies are positioned to diversify some of these risks.

Takeaway: Liquid alternatives may provide both diversification and investable liquidity in a correction, but GMO stresses that they are not insurance and that their effectiveness depends on the strategies, risks, and market conditions involved.