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ASSET ALLOCATION

Beyond the traditional lies a world of alternatives

A recent innovation on the food front—a plant-based burger that echoes the flavor and texture of meat—has captured the attention of many people, including the authors of this article, a sustainability champion and a vegetarian. Moving beyond the traditional is a theme with parallels in asset management. Investors are increasingly reaching beyond traditional to alternative asset classes to achieve outcomes similar to or better than what they’ve realized from public markets.

Given high valuations in public equity markets and lower yields in fixed income, we believe alternatives offer a strong solution as investors look to mitigate those pain points. We hone our views by utilizing an alternatives framework that is essential to building resilient portfolios that are able to reach beyond the traditional. Alternative portfolio construction should be holistic, comprising three basic components: a core foundation (think of a burger patty), with assets such as core real assets and core private credit, designed to provide stable income with lower volatility; core complements (the burger bun), with assets such as hedge funds adding diversification and uncorrelated alpha; and return enhancers (burger toppings), with assets such as special situations and private equity seeking opportunistic returns.

Alternatives framework: Overweight predictability and diversification

In EXHIBIT 1, we illustrate our alternatives framework, which we believe offers an innovative approach to investing in alternatives. It categorizes asset classes according to what they do for investor portfolios—not what they are. At the current market juncture, we suggest that investors overweight the components shown in purple.

Framework-driven portfolio construction: What role do different alternative categories play in the portfolio?

EXHIBIT 1: THE ALTERNATIVES SOLUTIONS BUILDING BLOCKS
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Source: J.P. Morgan Asset Management Alternatives Solutions Group. For illustrative purposes only.

Here’s how we come up with that particular focus: In the core foundation, we look to source returns from scalable categories with stable cash flows that are also diversifying vs. traditional assets; generally, we emphasize income and income growth over price appreciation. We think this is a prudent way to build portfolio resilience. In the core complements category, we like investments that focus on less trafficked and less transparent opportunities, as well as low beta categories that benefit from secular themes. Among return enhancers, we find attractive opportunities in special situations and categories of private equity, which can produce outsize returns across a market cycle. Right-sizing the mix of these various components should reflect an investor’s specific objectives and constraints. Later in the economic cycle, greater emphasis should be placed on the core foundation and core complements categories.

Beyond the traditional within alternatives

Beyond the traditional in the core foundation

Domestic core real estate is traditionally held in the core foundation. Beyond domestic real estate, investors can uncover a wide range of opportunities offering stable return streams from myriad cities and sectors. We recommend striking a global balance, with ideally 50% non-domestic. Beyond real estate are rapidly expanding segments including infrastructure and transportation, which offer greater income potential and diversification vs. both public markets and traditional real estate. Within private credit, investors can move past direct lending to find less crowded opportunities, from private residential mortgages to mezzanine commercial real estate lending.

Beyond the traditional in core complements

Moving beyond the traditional in hedge funds can take many forms. For example, beyond traditional quantitative investing are funds that can harness the power of machine learning (ML) to find new sources of uncorrelated alpha. ML systems identify patterns and continuously evolve to potentially enhance alpha generation across different market environments.

Beyond traditional long-short hedge funds are sustainable alpha strategies generating alpha from structural changes driven by long-term sustainability trends. For example, a strategy might identify winners and losers in a particular sector’s transition to a low carbon economy. Investors can earn attractive returns and have a positive impact by allocating capital to companies that are driving positive sustainable improvements and increasing the cost of capital for bad actors.

Beyond the traditional in return enhancers

Large buyouts have long been a traditional source of enhanced returns. Moving beyond traditional leveraged buyouts (LBOs) into small and midsize private companies, we recommend focusing on specialized strategies fueled by technological disruption. We also advise investors to transition beyond broad-based distressed lending to bespoke special situations that provide investment opportunities across credit cycles.

Conclusion

Beyond the traditional lies a world of alternatives. Think about what role alternatives play in a portfolio. Focus on what they do rather than what they are (just as vegetarians and omnivores enjoy meatless burgers as a sustainable source of protein). Investors who use an outcomes-based approach that looks beyond the traditional within alternatives can craft a resilient portfolio, one that satisfies an appetite for income and alpha.
 

OVERVIEWS AND OUTLOOKS BY ASSET CLASS

 


 
 


 
 


 
 


 
 


 
 
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