We see tremendous opportunity in private alternatives during the coming cycle, particularly when it comes to their ability to add alpha, income and diversification, that said it is important to recognize that an allocation to alternatives should be outcome oriented.
Global Market Strategist
Listen to On the Minds of Investors
Most investors are familiar with the return challenges they may face in the years to come. Elevated equity market valuations and historically low interest rates have led us to forecast that a 60/40 portfolio of global equities and high quality U.S. fixed income will return 4.2% annually over the next 10-15 years. This expected return will be insufficient in helping investors accomplish their long-term goals; as a result, alternatives will transition from option to essential in the years to come. But what is in store for alternatives in 2021?
Starting with core real assets, the outlook for real estate varies by sector, but there are opportunities across the board. In general, 2021 should see real estate continue a transformation driven by megatrends and the COVID-19 pandemic. Some assets – like those in the industrial sector – will continue to thrive, whereas others – such as those in the retail space – will need to adapt.
In private infrastructure, it is important to remember that these assets come with a variety of different flavors, shapes and sizes. Assets levered to the business cycle should bounce back strongly in 2021, while core assets will likely see less of a benefit from the economic reopening. Transportation, which is effectively moving infrastructure, should see larger, more stable players with access to capital and a focus on environmental sustainability outperform. In general, core real assets look set to provide a healthy stream of income in a very low rate environment, while also helping investors hedge against the risk of higher inflation.
The outlook for private equity remains positive, as long-term trends in technology and innovation have created opportunity for investors. Furthermore, the combination of significant dry powder and availability of debt financing has led to elevated valuations, increasing the importance of value creation and investment discipline going forward. On the debt side, we expect that investors will continue fleeing low-yielding public markets in an effort to find income; less-trafficked public markets and private debt markets seem like the logical place to go. Companies experiencing temporary disruption rather than demand destruction are attractive lending targets; at the same time, a gradual withdrawal of policy supports should lead default rates to rise, creating opportunity for distressed investors.
Finally, a macro environment characterized by solid economic growth, wide valuation and performance dispersion, and low interest rates should be broadly supportive of hedge fund performance. Furthermore, hedge funds are one way that investors can gain exposure to global megatrends – things like sustainability, the emerging market consumer and technology.
At the end of the day, we see tremendous opportunity in private alternatives during the coming cycle, particularly when it comes to their ability to add alpha, income and diversification. That said, it is important to recognize that an allocation to alternatives should be outcome oriented. The prudent investor will first identify the problem they are trying to solve, and then determine the best asset for achieving the desired outcome.
Alts can provide alpha, income and diversification, but manager selection matters
Private and public manager dispersion based on returns over a 10 year window*
Global equities (large cap) and global bonds dispersion are based on the world large stock and world bond categories, respectively. *Manager dispersion is based on: 3Q 2010 – 3Q 2020 annual returns for global equities, global bonds, U.S. core real estate and hedge funds. U.S. non-core real estate, global private equity and U.S. venture capital are represented by the 10-year horizon internal rate of return (IRR) ending 2Q 2020.
Data is based on availability as of January 21, 2021.