In today’s investment world it is important that investors have a broadly diversified portfolio, and this includes incorporating an allocation to alternatives.
As current demographics push more of the population into retirement, there is a broader demand for income as traditional asset classes are not providing the same level of income they might have done in the past.
In many respects, some parts of the alternatives market are more stable and less complex than investing in equities and can provide that income buffer. Given the lacklustre returns and income from bond markets, some of the more stable cash generative alternative sectors might provide an attractive substitute. They tend to have limited exposure to the wider economy and tend to provide long-term stable returns.
With increasing worries about the impact inflation is having on real returns, driven by expansionary fiscal and monetary policies, many of these alternative investments are protected with inflation-linked revenues, and so are far better protected than bonds against the ravages of inflation.
Where to start?
There are varying degrees of complexity in all markets, but listed infrastructure and renewables assets tend to be fairly straightforward business models generating stable cash flows and paying them out in the form of dependable dividends.
There are less risks of merger and acquisition activity or management teams moving into unrelated business areas and surprising investors, as their business models tend to be very focussed on a particular activity, for example, solar or wind farms, battery storage or PFI projects. As a result, investors know the underlying exposures they are investing in and the sensitivities to changes in inflation or costs.
With more complex investments such as hedge funds, private equity or leveraged credit, we believe investors need to be more cautious as they can be more sensitive to the economic backdrop and financial market conditions, so a good understanding of what the portfolios are currently made up of is important as this can change quite quickly depending on the managers’ views.
If we take the example of a renewables company, investors know they will be exposed to power generation output, subsidies the sector benefits from and, to some degree, the power price. All of this tends to be relatively stable over time and far less correlated to the economic backdrop, which equities are far more exposed to.
While we saw a lot of dividend cuts through the pandemic, all listed renewable and infrastructure companies continued to pay their dividends, highlighting the strength and uncorrelated nature of the asset classes and great diversification benefits you can get from owning them as part of your portfolio, particularly for income investors.
It is quite surprising we do not see more equity fund managers, particularly income managers, allocating investment to the sector as it is fairly defensive and dependable for income. It is also part of UK equity benchmarks, given they are listed securities and many of them have outperformed the FTSE 100 over the longer term and are far less volatile.