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Principles of alternatives investing
Explore 9 key principles for investing in alternatives
In our Principles of Alternatives Investing we provide 9 key insights to help investors understand alternative investments and the impact they can have on portfolios.
Alternatives can improve portfolio risk and return
Alternatives and portfolio risk/return
We receive lots of questions about how alternatives can be used in the context of traditional portfolios.
In general, an allocation to alternatives should be outcome oriented – in other words, step one is identifying the challenge you are trying to address, and step two is allocating to the asset that will provide the desired solution.
Click on the respective pie charts to view the portfolio examples.
Investor participation is increasing rapidly
Global private capital fundraising
Fundraising each year into private equity, private credit, real estate, infrastructure, and natural resources remains robust, illustrating the strong growth in closed-end funds.
Alternative investments require an outcome-oriented approach
Public and private market correlations
Alternative assets can enhance diversification in portfolios through uncorrelated or negatively correlated returns, shaded in green. Real estate, real assets, and select hedge fund strategies can help to further diversify a portfolio of stocks and bonds. Other areas of the private markets, like private equity, are positively correlated to public equities, but provide opportunities for return enhancement.
Click on a tile within the chart to explore the correlations.
Real assets can provide income and reduce volatility
Equity market correlations and yields
The bond market provides one of two things in the current environment – protection without income, or income without protection. As such, investors have been forced to take on more equity risk in order to generate the income they need. Alternatives, however, and particularly core real assets, can provide investors with credit-like yields without the elevated correlation to equities.
Click on the points on the chart to view the data.
Alternatives
| S&P 500 Cor. | Hedge Adj. Yield | |
|---|---|---|
| Direct lending | 0.66 | 7.7% |
| Infra. | 0.07 | 4.19% |
| U.S. Real estate | -0.16 | 3.81% |
| APAC Real estate | -0.13 | 4.24% |
| Europe Real estate | -0.02 | 3.72% |
| Transport | -0.09 | 13.6% |
| CML - Senior | 0.3 | 3.68% |
| Timber | 0.07 | 3.39% |
International
| S&P 500 Cor. | Hedge Adj. Yield | |
|---|---|---|
| Japan | -0.04 | 0.7% |
| Germany | 0.07 | 1.25% |
| UK | 0.04 | 1.36% |
| Euro Corp. | 0.61 | 1.8% |
| Euro HY | 0.79 | 5.13% |
| EMD (LCL) | 0.49 | 5.71% |
| EMD ($) | 0.64 | 5.68% |
| EM Corp. | 0.68 | 4.49% |
U.S. Non-Government
| S&P 500 Cor. | Hedge Adj. Yield | |
|---|---|---|
| Floating rate | 0.76 | 0.62% |
| U.S. HY | 0.81 | 4.9% |
| MBS | -0.11 | 2.26% |
| U.S. Aggregate | 0.02 | 2.05% |
| Munis | 0.26 | 1.47% |
| U.S. corps | 0.49 | 2.7% |
| Convertibles | 0.84 | 5.99% |
U.S. Government
| S&P 500 Cor. | Hedge Adj. Yield | |
|---|---|---|
| 2y UST | -0.32 | 0.98% |
| 5y UST | -0.36 | 1.48% |
| 10y UST | -0.37 | 1.79% |
| 30y UST | -0.37 | 2.2% |
| TIPS | 0.22 | 1.66% |
Hedge funds can diversify traditional stock/bond portfolios
Hedge fund correlation with a 60/40 stock-bond portfolio
Hedge funds have provided downside protection during periods of market stress, shown in blue. During most of the periods of acute market stress over the last thirty years, macro hedge fund correlation to a 60/40 stock-bond portfolio has fallen to zero or below. Correlations came down in 2020, although not as far as during other periods of volatility, likely because market volatility during COVID was so brief relative to past downturns.
Scroll the timeline and click on the blue data points to explore the events that correspond to periods of market stress.
Private markets are larger & dominated by growth companies
Number of listed U.S. companies and market cap.
The demand for private equity has grown as a means to access opportunities not available in public markets. Although a robust IPO market has increased the number of listed companies in the past two years, it still remains below the levels of the 1990s as more companies remain private for longer. However, while the number of public companies has decreased, on aggregate we now see a higher market capitalization – illustrating the public equity market is now more dominated by larger companies relative to history.
Direct lending is resilient during periods of economic stress
Expansion
During an expansion, companies tend to see profits increase, leading to upgrades in riskier areas of the credit market, such as high yield and leveraged loans. At the height of the expansion, direct lending benefits the most and has historically led in terms of returns among credit.
Late cycle cooling
As the economy begins to cool, Treasuries, investment grade and direct lending can be good sources of downside protection. Although high yield has historically remained resilient, weaker quality companies emerge from the “turnaround” in relatively strong health.
Recession
When the economy is in a recession, the contraction in economic growth pushes the weakest companies into default and downgrades riskier areas of the credit market. As such, high yield and leveraged loans tend to underperform, while higher quality credit such as Treasuries, investment grade and direct lending remain more resilient during times of economic stress.
Turnaround
As the economy emerges from a recession (“turnaround”), the outlook for credit downgrades and defaults improves and investors find opportunities further out on the risk spectrum in areas like high yield and leveraged loans. Usually the recession pushes the weakest companies into the default and downgrades weaker areas of the investment grade market, and lending standards tighten, so the high yield and leveraged loans sectors have typically actually moved up overall in quality, and should benefit from improving economic conditions and credit markets.
Hover over the bars in the chart to explore the data.
Manager selection matters more in private markets
Dispersion of manager returns
Manager selection is critical to strong returns, perhaps even more so in alternative investments.
Dispersion in performance is pronounced in non-core real estate, private equity, venture capital, and hedge funds, underscoring the importance of choosing an effective manager to unlock the return-enhancing potential of alternatives.
Hover over the bars in the chart to explore the data.
Alternatives can help diversify portfolios, as well as each other
Alternative asset class returns
Alternatives can diversify traditional portfolios, as well as each other. Over the 10-year period from 2011 to 2020, venture capital, private equity and infrastructure lead the way in terms of returns, while hedge funds came in at the bottom – with their performances in the earlier half of the decade bringing down the cumulative number. A balanced exposure to alternatives, as illustrated by “Asset Allocation,” would have generated an annualized return of 10.8%, below that of VC and PE, but with lower volatility.
Hover over the tiles in the chart to explore annual returns.
View the full guide now
Our Guide to Alternatives is designed to simplify the complex world of alternative investments and help you make investors make more informed decisions across real estate, infrastructure, private markets and hedge funds.
