Alternative investments can play a crucial role in diversifying portfolios and offering better risk-adjusted returns, according to UBS. The financial services firm highlights several opportunities in the alternative investment space, including specialist credit hedge funds, macro hedge funds, secondaries in private equity, and private debt. UBS suggests that adding 20% of alternatives to a balanced portfolio can increase expected annual returns. In the previous year, diversified alternatives' indexes delivered performance ranging from -6% to +17%. UBS also notes that credit long/short funds have historically outperformed traditional credit after a market sell-off, while private loans offer attractive yields. The firm particularly favors specialist credit hedge fund strategies and secondaries in private equity. Additionally, UBS believes that higher interest rates can support the return potential for alternative asset managers. However, investors are advised to understand the risks associated with private assets, including illiquidity and the use of leverage.
Alternative assets such as private equity, infrastructure, and renewable energy have not delivered the returns they promised during periods of stock market volatility, as highlighted by Interactive Investor. These assets have been negatively impacted by rising interest rates, which have led to higher yields on government debt and decreased the value of alternative assets. However, the recent good news on US and UK inflation may change this trend. With interest rates expected to fall in the UK and Europe, the negative effects on alternative assets may be reversed. The UK's National Infrastructure Commission and the government's financial incentives for the offshore wind sector also provide potential investment opportunities in renewable energy and associated infrastructure. Despite the challenges, some managers in the alternative assets space believe that the market sell-offs caused by risk aversion have dragged down funds unjustifiably. Analysts are optimistic about the listed private equity sector, which is currently trading at attractive discounts. However, investors should carefully consider their options and diversify their exposure across different specialist areas in their portfolio. The extreme disconnect between alternative assets and equity funds highlights the oversold nature of the alternative assets space.
UK defined contribution (DC) schemes have been slower to invest in illiquid assets compared to other types of schemes. However, with long-term investment horizons, DC schemes are well positioned to benefit from the potential illiquidity premium. The government, Financial Conduct Authority, and Bank of England have been working to facilitate investments in illiquid assets for DC investors. While there are potential pitfalls and underappreciated risks associated with illiquid investments, DC schemes need to adjust their portfolios to optimize risk-adjusted returns and resilience. The September 2022 Mini Budget exposed the vulnerability of UK defined benefit (DB) pension schemes to liquidity issues. DC schemes, although not needing liability-driven investment strategies, may face reduced flexibility due to increased illiquidity. Illiquid assets have lumpy cashflows and may require selling assets at inopportune moments. Achieving positive returns in a DC portfolio requires owning assets that respond differently to changes in the investment environment and each other. Private market proxies have shown a higher correlation with global equities than expected, indicating a persistent lockstep correlation. If DC schemes increase investments in illiquid assets, their portfolios may resemble a barbell, with heavy weightings in listed equities and bonds on one end and illiquid assets on the other. Balancing the barbell ends with an uncorrelated strategy that offers downside and inflation protection, liquidity, and improves risk-adjusted returns is crucial. The article emphasizes the need for diversification and careful portfolio management in the face of potential market volatility and correlation conundrums.
Private capital is increasingly being used to finance consumer spending as banks lend less to consumers. This presents an opportunity for investors to boost return potential and diversify private credit portfolios. Asset-based finance, which includes the purchase, origination, or financing of assets sourced through specialist lenders, is a broad form of consumer lending that powers the real economy. It is a $6.3 trillion market and provides financing for residential and commercial property, cars, credit cards, small business loans, and more. However, asset-based finance remains underrepresented in investor portfolios due to the limited number of private credit managers capable of navigating the opportunity set. The market is expected to grow to almost $10 trillion by 2028. Asset-based finance offers diversification, a hedge against inflation, ample cushions, and additional lender protections. It also provides an appreciable yield premium. North America and Europe are the two largest and most accessible markets for asset-based finance, with North America being more mature and Europe offering varied opportunities. The article suggests that asset-based finance stands today where corporate direct lending did a decade ago and expects rapid and sustained growth in the future. This presents an opportunity for investors to increase potential return, downside protection, and overall credit allocation diversification.
Overall, alternative investments and asset-based finance offer the potential for diversification and risk-adjusted returns, but investors should be aware of the challenges and risks associated with these assets, including illiquidity in UK defined contribution schemes.