Is the equity market an alternative to the low rate in Europe?

Economie Union Europenne

The financial crisis has led to the fall in bond yields across Europe. The risk-free yield that government bonds provided is almost non-existent today, or even negative for some countries. The collapse of rates has led to the disappearance of a secure financial windfall for many sectors, particularly the insurance sector. To make up for this shortfall, a viable alternative to obligations must be found. The equity market offers this opportunity if, however, innovative strategies are applied that differ from traditional approaches. Several equity strategies have expanded in recent years thanks to the willingness of large groups to reallocate part of their bond portfolio to equities.

The major problem for equities compared to fixed income products is their higher volatility and therefore a higher level of risk. However, strategies such as risk arbitrage or equity market neutral provide a good alternative to fixed income products for investors who are highly risk averse. These two types of funds, which are invested entirely in equities, differ from traditional funds. The goal is to minimize risk while providing a suitable return. These funds are called “absolute performance” because their performance is not dependent on an index, everything is done to constantly outperform the market through quantitative and/or qualitative analyses.

The arbitrage risk of announced mergers and acquisitions ensures an attractive risk/return ratio and a risk profile of 2/7. It is an alternative way to invest in a 100 percent equity fund with a much lower risk than these peers. Performance does not result from a performance driver usual in the equity market but from financial arbitrage between two securities. Of course, the risk is not non-existent but is uncorrelated to the daily performance of the share price. A gain arises when the merger and acquisition transaction is completed and the share of the acquired company reaches the price of the parent company’s share price.

The aim of the “Market Neutral” strategy is to build a portfolio that is uncorrelated to the equity market in a quantitative way. This means an equity portfolio with a Beta close to 0 or as low as possible. As a result, the portfolio does not reflect market fluctuations. Several performance drivers are taken into account such as the “Basket Momentum” and the “Mean Reversion”. The algorithm that manages the fund is constantly correcting its market positions to optimize the market neutral approach. This type of fund is paradoxical because it often generates alpha when all funds with a traditional strategy stagnate and do not show a very strong performance in Bull Market, a contrario it performs when the market stabilizes.

The equity market is an alternative to the bond market. However, it is a partial alternative, very often only a part of the bond pockets are redirected to absolute performance funds. Exposure to the equity market is often frowned upon by investors, resulting in companies’ reluctance to optimize their equity positions. But there are other ways to diversify your portfolio. The European High Yield offered good yield prospects at the beginning of the year with spreads higher than the American High Yield which is too exposed to oil. Convertible bonds, green bonds and cat bonds are also products that can provide attractive return opportunities with measured risk.


Aimeric Duparay


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