Alternatives: As the dust settles

Although the dust is still settling on valuations, alternative investments can support the outcomes investors seek in portfolios.

Public markets repriced significantly in 2022; 2023 was supposed to be the year when private markets followed suit. Repricing has begun and is still in various stages. It is still underway in real estate. It has been somewhat more benign thus far than expected in private equity as profits and economic growth have been resilient. It is likely yet to come in private credit once the economy slows, higher-for-longer interest rates apply pressure to floating rate loans and defaults pick up. Because transaction volumes have been lighter, it can be difficult to get a firm gauge on valuations as assets simply aren’t trading frequently enough to give a clear barometer.

Still, although the dust is still settling on valuations, alternative investments can support the outcomes investors seek in portfolios. Some of the most pressing concerns for 2024 will likely be diversification, inflation hedging and alpha. 

Diversification proved elusive in 2023. Bonds are tracking to narrowly avoid a third consecutive annual decline and interest rate volatility has been severe. Assets like gold and the U.S. dollar are expensive and produce no income. If diversification proves to be evasive again in 2024, infrastructure investments have provided low or negative correlation to the public markets and stable income with minimal volatility over time. With industrial policy back in vogue across the U.S., Japan, India and Europe, the structural tailwinds are robust.

U.S. inflation saw significant declines in 2023 and could reach the Fed’s 2% goal sooner than anticipated in 2024. However, as we note in our Long-Term Capital Market Assumptions, U.S. inflation could be closer to 2.5% over the next decade. If that is the case, real estate has proven to be an effective inflation hedge over time as higher costs can be passed on via higher rents. Public REITs have already repriced notably and could be the first place to deploy capital. 

Unexpectedly buoyant public equity markets lavished investors with double-digit returns in 2023. However, higher-for-longer rates may pose a challenge to beta but allow alpha producers like stock pickers and private equity managers to shine in a less navigable environment going forward. In fact, history shows that performance from vintage years (the year when a private equity fund first deploys capital) that are economically challenging have tended to produce higher median returns. Still, quality and selectivity will be critical in both public and private equity (Exhibit 1).