LONDON, Nov 22 (Reuters) - Investors are going to have to work far harder in 2014 to replicate this year's bumper gains by turning over more trades or pushing out into riskier investments.
Those who did nothing other than park money in major developed equity indexes at the start of the year are now sitting on handsome returns of more than 20 percent, thanks largely to extraordinary monetary support from central banks.
But next year is unlikely to be so easy. And this is not just an issue for 2014 - as the wider institutional investment community has been struggling to produce consistent long-term returns required to meet the needs of an ageing society.
"I don't think there's an outstanding trade in 2014 that's obvious. I think 2014 is going to be tricky, to capture value you're just going to have to be tactical," said Chris Goekjian, chief investment officer of hedge fund Cheyne Capital.
"There's not one asset class that I think is going to be massively distorted. It's just going to be one of these environments where you have to be quick on your feet, avoid getting wrecked along the way."
Moving away from benchmark-hugging passive investing will be crucial in emerging markets like China where big state-controlled companies with poor earnings make up the bulk of indexes.
Instead, consumer-related sectors could outperform, as well as any technology companies which may list their shares, according to Didier Saint-Georges, a member of the investment committee at Carmignac Gestion.
"2014 is the year of active management ... If you just buy the equity index it's not where you are going to do very well. It's a lot of hard work to find those companies," he said.
Some investors may be hoping to make up gains by trading a lot more frequently and doing a lot of small profitable deals.
But others are pushing into riskier and more illiquid trades to capture attractive returns.
Cheyne has around $1 billion of its $6.5 billion portfolio in private credit, where it directly lends to corporates and real estate projects on a 5-6 year horizon for its clients. They include pension funds and sovereign wealth funds.
Its event-driven fund - a strategy that trades on mispricing of equity prices surrounding corporate events such as merger or bankruptcy - is also making double-digit returns.
Amundi has invested in event-driven strategy by U.S. hedge fund Paulson & Co which has made 20 percent so far this year after fees.
Paulson's strategies incorporate merger arbitrage opportunities on announced deals as well as more complex hostile transactions, exchange offers, restructuring and bankruptcy reorganisations.
Billionaire investor John Paulson, who earned $15 billion with a bet against subprime mortgages in 2007, has been favouring Greek banks. However, his gold bet was wrong-footed with a loss of 65 percent in the first half of the year.
For long-term institutional investors who prefer buy-to-hold investments to quick trades, illiquid deals are playing a greater role in their portfolios.
A report by State Street's Center for Applied Research shows a globally diversified portfolio including alternatives generated 70 percent enhanced performance net of fees with marginally higher volatility versus a more traditional portfolio composed of 60 percent equities, 40 percent bonds.
Pension funds based in OECD member states increased allocation to alternatives to 19 percent of assets in 2012 from 6 percent in 2000.
The main example of that is Canadian pension fund OMERS, which manages the pension plan for Ontario's municipal workers. OMERS, which manages C$60 billion ($57 billion) in assets, has become a global dealmaker by buying up private equity, property and infrastructure assets around the world.
The fund made a 10 percent return on investments in 2012.
Previously risk-shy, more pension funds may need to follow this approach if they aim to match assets with their growing liability.
And they are constantly undershooting their return targets. A commonly assumed annual rate of investment return for U.S. state and municipal pension funds is around 7-8 percent. Since 2000, the actual return has been around 5.6 percent.
According to U.S. money manager GMO, the compound return for the S&P 500 since 1970 has been 5.7 percent.
"If 5.7 percent real is no longer a reasonable guess at an equilibrium return for U.S. equities ... if equity returns for the next hundred years were only going to be 3.5 percent real or so, today's prices are about right," wrote Ben Inker, GMO's co-head of asset allocation.
"But every pension fund, foundation, and endowment - not to mention every individual saving for retirement - would be in dire straits, as ever, investors' portfolio return assumptions build in far more return." ($1 = 1.0512 Canadian dollars)
(Editing by Susan Fenton)