Easing the ride in turbulent markets

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Easing the ride in turbulent markets

In the short term at least, this has had the desired effect. In equity markets, the FTSE 100 index has come within a whisker of the 7,000 mark, while the S&P 500 index has continued to reach new highs. But bond markets have also soared, pushing yields to record lows – the idea that bonds and stocks move in opposite directions is looking like a fallacy.

Apart from understandable concerns about valuations, the current investment environment is challenging for anyone looking to diversify their portfolio. Investors want new sources of return and many alternative assets have grown so much in popularity they are already heading towards the mainstream – real estate, hedge funds and private equity have all grown in popularity in recent years.

More esoteric areas, which were previously considered the domain of a narrow band of investment experts, are being deemed worthy of consideration. The main attraction of these assets is they provide a different return stream to both traditional asset classes and those that have been considered alternatives.

Investors who require stable streams of cash returns, which are increasingly hard to find in traditional fixed income markets, are looking towards infrastructure investments. The infrastructure of the renewable energy industry is very interesting. It includes producers of renewable energy such as wind and solar farms, hydroelectric, biomass facilities, and wave and tidal technologies. Construction of more infrastructure in these fields and the continued operation of existing assets are crucial to the UK’s ability to produce enough renewable energy.

It would not be a surprise if some of the fiscal largesse came in the form of further infrastructure spending, with potential opportunities for the private sector working alongside government.Richard Dunbar

On its own, state funding does not provide enough capital to build and sustain such undertakings – private funding must make up the shortfall. When building wind farms, investments are usually made by utility companies, while solar power facilities are often funded by private developers. Neither are natural long-term owners of the finished product, however, and this is where closed-ended renewable infrastructure funds come in. A number of funds have been set up to buy wind and solar farms and are now providing relatively attractive returns, with dividends often in excess of 6 per cent.

It is a world in which central bankers feel they have done all they can with monetary policy and are now handing the growth baton to governments and their use of looser fiscal policy. It would not be a surprise if some of the fiscal largesse came in the form of further infrastructure spending, with potential opportunities for the private sector working alongside government.

Meanwhile, peer-to-peer lending has grown in popularity, largely because high street banks started withdrawing lending to small businesses. The market is run by companies that set up platforms for loans that match lenders and borrowers. A scrupulous credit-rating check on potential borrowers is undertaken by the platform operators and a rate of interest set according to the borrower’s creditworthiness. Potential lenders can then choose the level of risk (and potential reward) they want to take on.

This is a market that is not without risk – as ever, it is easy to lend but not always so easy to get the money back. But there are good players in this market and banking models must change given new regulation and increased capital requirements on traditional lenders.

On a larger scale, the global loans market is an area in which opportunity has arisen due to the scaling back of lending by banks. Unlike a bond, the loan is paid back over its length, rather than in one payment at the end of the term.

Loans also rank higher than bonds in a company’s structure, meaning lenders get more back if the company defaults on payment. Companies also rank loan repayments above bond repayments, yet interest rates are typically higher, meaning a potentially attractive level of income.

Diversification by buying poor-quality assets will just lead to lower returns. Investors need to do their homework and buy diversifying assets on merit, not just because they are different. But the assets outlined do provide the potential for attractive returns, which have a low correlation with those provided by more mainstream assets.

Alternative assets should not be seen as a panacea and they will certainly not all thrive in a bear market, but when held as part of a diversified portfolio, exposure to the right alternative asset funds will help investors to both boost returns and smooth the ride through any future market turbulence.

Richard Dunbar is senior investment strategist, investment solutions at Aberdeen Asset Management