InvestmentsMar 21 2023

The role of alternative assets in current market conditions

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The role of alternative assets in current market conditions

The period from the global financial crisis of 2008 to the first interest rate rise by the US Federal Reserve in 2022 will probably be known to history as the quantitative easing era.

QE pushed the prices of bonds upwards (and so the yields downwards) and also boosted equity and property markets. 

When all of those asset classes were going up at the same time it presented a dilemma for investors, as the textbooks from which they obtained their professional qualifications were all framed around the premise that bonds and equities move inversely to each other.

Alternative investments were really born out of zero interest rate policy, and marketing teams of fund houses salivated as they rolled out a plethora of funds that targeted the vulnerable.James Sullivan, Tyndall Investment Management

Amid these market conditions, investors turned to alternative assets in search of diversification, and, in some cases, in search of the income not readily available from the mainstream asset classes. 

And so emerged funds that invest in music royalties and aircraft leasing, student property and healthcare, hedge funds and long/short funds. 

David Coombs, head of multi-asset funds at Rathbones Unit Trust Management, says: “Ultimately, those things aren’t really alternative. All investments are either buying a share of the future cash flow of an asset, so its equity, or lending money to someone, which is debt. And really, that's how one should think of it.

"How confident are you in the reliability of the cash flows on offer, and are those attractive to buy at the current price? And when it comes to debt, ask yourself, do you want to lend to them?

"And it’s not about saying all of those things are bad investments all of the time, just so that investors need to understand what it is they are owning if they invest in these assets.” 

Higher interest rates globally mean investors can now access a potentially meaningful level of income via cash or government bonds, and the textbook correlation between fixed income assets may be restored, with both of those factors denting the appeal of alternative investments. 

James Sullivan, head of partnerships at Tyndall Investment Management, is another who is sceptical of the investment case for alternatives. 

He says: “Alternative investments were really born out of zero interest rate policy, and marketing teams of fund houses salivated as they rolled out a plethora of funds that targeted the vulnerable: those in need of returns with a bond-like dynamic.

"There remains a place for alternatives, and the investment universe is more colourful with their presence, but for once in their short existence, they have a very credible challenge from the risk-free rate that is T-bills.

"I would like to see the risk premium somewhat higher than it is right now; I want to be paid appropriately for the credit risk that I am taking with exposure to alternatives, and arguably, that premium has evaporated over the course of the last six months.”

Fahad Hassan, chief investment officer at Albemarle Street Partners, is more positive on alternative investments, but says investors need to be aware that they tend to come with higher fees than conventional funds, and “are hostage to the financial backdrop”, rather than a diversifier away from economic conditions.

The alternative assets he owns right now are global infrastructure investment trusts. He prefers the investment trust structure for these as it ensures liquidity, and says investors looking at the alternatives need to be mindful that by their very nature those assets will be less liquid than equities or bonds. 

Yield control

Despite his comparative positivity around the asset class, Hassan has reduced his infrastructure holdings in 2023 as a result of higher bond yields.

Fahad Kamal, chief investment officer at SG Kleinwort Hambros, is generally pessimistic on the outlook for the global economy and for equity and bond markets. 

This is part of the reason why the portfolios at his firm presently have around 5 per cent allocated to alternative assets.

Among those on which he is keen are infrastructure funds, but also real assets funds that invest in physical roads and prisons, and supermarkets. 

The funds in which he invests essentially own these assets and rent them to government agencies or private companies. 

Kamal is keen on the investment case for these assets as the rental income is often linked to inflation, and so holds its value.

The capital for his allocation to real assets has come from reducing his exposure to bonds, as the income from bonds is not generally inflation-linked. 

James Klempster, deputy head of the multi-asset team at Liontrust, says assets such as gold and infrastructure, “can have a role to play, but they do a very specific job, usually around inflation protection, and so there are times when that job is more important than others”. 

Alex Hardy, a multi-asset investor at Momentum Investment Management, is another who is keen on real assets for their ability to protect against inflation, but he is very sceptical of the other approach to alternative assets, which involves allocating capital to hedge funds.

He says such strategies rely on an individual’s ability to “get the macroeconomic picture right, but the problem is that actually very few can do that consistently.

"We would rather own companies that are well-run; those businesses, over the long term, find a way to thrive, and we think that’s a better approach than trying to get the economic outlook correct.”

Hardy says his allocation to real assets funds is “strategic” and not just a function of the present, or recent, market conditions. 

David.Thorpe@ft.com