Beyond traditional assets: Why investors should be alternative [Quarterly Perspectives] - J.P. Morgan Asset Management

Beyond traditional assets: Why investors should be alternative [Quarterly Perspectives]

Contributor Global Markets Insights Strategy Team

Traditional asset classes have produced impressive returns in recent years as equity markets rose and bond yields continued their multi-decade fall. As the price of these familiar assets has risen, so investors have become understandably concerned about the potential for future returns. Investors could well enjoy positive returns across equity and fixed income assets in coming years, but the need to seek alternatives is clear.

The intuitive first step is to diversify within traditional markets. Fixed income investors with concentrated exposure to core bonds should augment those holdings with a range of other fixed income assets, such as global high-yield corporate bonds. Investors with equity exposure to their their own country alone would be wise to look further afield for higher returns and diversified risk exposure. But in this environment, these modifications to portfolios may not be sufficient to meet investors’ return goals and protect against drawdown risks, so investors should consider other “alternative” investments.

Alternative investments cover an array of strategies, asset classes and investment approaches that differ from traditional long-only investment asset classes, such as equities, fixed income and commodities. Including alternatives in a portfolio, alongside traditional holdings, can often improve overall performance for investors.

For investors in traditional asset funds, the first port of call will probably be “liquid” alternatives: strategies and assets that are packaged into funds just like those that focus on traditional asset classes. An example of a “liquid alt” is a long-short equity fund that seeks to improve risk and return characteristics in all markets, complementing a portfolio of investments with bets that pay off if the price of the security falls. These funds, some of which fall under the category of hedge funds, are therefore able to perform better across different market environments than some traditional asset classes.

Many alternative investments are, by their nature, illiquid-and, for investors who are prepared to take on that illiquidity risk, have the potential to generate greater returns. This is particularly evident in the private credit and private equity segments. Private credit involves extending loans to businesses, often with no prospect of selling those loans in a secondary market. With careful research, private credit funds attempt to supply loans at attractive interest rates to parts of the economy that are not well served by more traditional funding options. This often involves tailored covenant packages that are agreed between borrower and lender, which can improve risk management for both parties.

Meanwhile, private equity investments often involve taking part ownership in firms, often at an early stage of their life, in the hope of supporting and benefitting from rapid growth. Exiting the position can frequently involve taking the company public: an outcome often years into the future and with a very uncertain pay-off. With the age at which companies are going public currently between five and seven years, and rising, private equity is an increasingly important channel to access growth companies.

Both private equity and private credit involve painstaking research into individual companies. On the equity side, in particular, there can be huge rewards for successfully spotting good opportunities, and severe penalties for getting it wrong. The extreme range of outcomes explains why the dispersion of returns between individual private equity funds is more pronounced than public equity funds. This dispersion varies by fund size, and narrows as the fund size increases.

Significant holding periods are also a feature of many alternative investments, including private equity and private credit. But the longest holding periods usually belong to real assets, such as infrastructure and real estate. These allow investors to lock in predictable long-term cash flows by purchasing, and running, many physical assets.

Investment implications
  • Alternatives include a diverse collection of strategies and assets which can play a role in improving portfolio return and controlling risk.
  • Some alternatives are available in “liquid” form. Often these involve exposure to traditional assets but through different investment styles.
  • However, lack of liquidity, significant minimum investment sizes and long required holding periods make some alternative investments unsuitable for many investors.
  • Furthermore, alternative investments often involve greater risks than traditional asset classes (including the use of leverage and speculative investment techniques) and should not be deemed a complete investment programme on their own.
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Please be aware that this material is for information purposes only. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are, unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all-inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you. JPMorgan Asset Management Marketing Limited accepts no legal responsibility or liability for any matter or opinion expressed in this material.

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