Outcomes matter, and so do alternatives
At the end of the day, deciding which assets to allocate to is only the first step of the alternative investment process. Manager selection remains of the utmost importance.
Global Market Strategist
In the first quarter of this year, the 10-year U.S. Treasury yield increased 82bps, its largest quarterly increase since 4Q16. This led the Barclays U.S. Aggregate Index to fall by 3.37%, its worst quarter since 3Q81. Rate volatility has subsided, but equity valuations remain elevated and long-term return expectations are muted. So what is an investor to do?
More and more clients are turning to alternatives — both public and private — as a solution in a world of low rates and meager expected returns. As we have written before, any allocation to alternatives should be outcome-oriented; first, investors need to identify the problem they are trying to solve, and then determine the asset or strategy that will provide a solution.
Commercial real estate is finding its footing. Although some questions around the office and retail sectors remain, the reopening of the economy this summer will begin to provide some insight as to how these sectors might evolve going forward. It seems that offices will increasingly become places for collaboration, rather than individual work, and success in the retail sector will be driven by properties that are oriented toward the consumption of services and experiences, rather than goods. Core real assets broadly can provide uncorrelated streams of income and inflation protection, helping to address some of the challenges posed by the bond market.
Exhibit 11: Tenant mix matters for retail properties
% Change in number of retail establishments, 3Q10-3Q20
Momentum in private equity deal activity seems to have carried over to 2021. In the buyout space, purchase price multiples remain elevated, and this could very well remain the case. Robust demand for high yield debt has not only provided support for private credit markets, but may also allow more leverage to be applied in the deal process.
Exhibit 12: U.S. LBOs: Elevated multiples may stay elevated
U.S. LBO purchase price multiples, equity and debt over trailing EBITDA
The outlook for hedge funds will be dependent on the path of volatility. Retail investors seem to be returning to the stock market, and the economic reopening may create more questions than answers. As such, we see room for volatility to increase in the coming months, supporting hedge fund performance. Furthermore, with credit spreads at the low end of their range and equity valuation dispersion still wide, relative value and long-short strategies are particularly attractive.
At the end of the day, deciding which assets to allocate to is only the first step of the alternative investment process. Manager selection remains of the utmost importance. As we journey into a post-pandemic world, there will be more questions than answers — alternatives can play a role in providing income, enhancing return and managing risk.