Investors woke up to alternatives in 2022 as an essential part of portfolios after bonds and equities “glitched” and fell at the same time in response to higher interest rates.
However, “alternative” it a broad definition including multiple asset classes, each with their own future prospects, meaning investors need to take views on a variety of areas.
Below, JPMorgan Asset Management global head of alternatives Anton Pil shares his take on which alternative investments should deliver for investors going forward and which might not be worth it.
Private equity
First up is private equity, which is becoming more and more difficult to ignore for investors, as private markets are as large or larger than public markets.
Pil was particularly interested in smaller and mid-sized companies, as they generate value through operational improvements and expansion, which are easier to achieve at lower capitalisations (in contrast, larger companies typically depend on financing markets to carry out leveraged buyouts, the number of which has shrunk in the current higher interest rate environment).
What makes the market “very exciting” are the secondary opportunities generated by an imbalance between capital calls and distributions – in a normal year, private equity investors get distributions (returns) from some investments, as companies are sold and cash paid back, and pay more into companies that release capital calls.
Usually, the two are roughly equal and one’s allocation remains the same. But last year and so far this year, that has changed, said Pil.
“The distributions coming out of private equity vehicles have shrunk, and while you're not getting that cash out, you're still getting the capital calls,” he explained.
“And that imbalance is where a lot of the opportunity lies, because it's forcing some people to be sellers of their overall equity positions, which means that there's a much larger secondary market taking place in private equity.”
Private debt
Conversely, Pil was much more negative towards private equity credit, although the asset class has been popular among many asset allocators for its great performance and high-single-digit yields.
“The asset class will continue to grow as bank regulations tighten balance sheet expenses for banks and people disintermediate banks with private credit. However, so much money has flowed into private credit in the past 12 to 24 months that the spreads you're getting paid relative to high yield are probably not that attractive,” he said.
“So although it is higher than high yield, you have to get paid a illiquidity premium for the fact that you're in an asset that is not liquid and tradable, and that premium today doesn't exist or is very thin.”
On top of that, Pil is also increasingly put off by signs of credit stresses in the private credit market, as well as by the number of investors who are finding out that they have too much private debt and are actively selling their positions.
Commercial real estate
Real estate markets have been falling dramatically, with some US buildings shedding 30% or more of their value. This makes sense in the higher interest-rates environment, but here, Pil has a “somewhat controversial view”.
Offices in particular have been in trouble since the working-from-home phenomenon, with prices dropping the “most in the US, somewhat in the UK, and a little bit in Europe”.
But the concept of working from home as being a permanent shift is going to be “really tested when a recession happens”, according Pil, as working from home “could be a bull market phenomenon”.
“All those people who work in an office still need an office, so if you think that offices are going away, I disagree. In fact, since September last year, we've started seeing occupancy rates exceeding 80%,” he said.
“But valuations in many cases are still skewed towards the assumption that offices won't come back. I do think office valuations are beginning to bottom out.”
Infrastructure
Finally, Pil is “very focused” on infrastructure, which has been a traditional asset class in Europe for more than a decade, but it’s fairly new in the Americas, he explained, and has been gaining “unabated attraction”.
“The sector is going to need absolutely huge amounts of capital over the next 10 to 20 years for projects across the spectrum, including the energy transition, transportation and impact investing,” he said.
“On top of that, infrastructure projects also have stable cash flows and highly regulated the central services to add to their appeal.”