- Many investors have started looking beyond traditional assets in the search for diversification and higher returns
- Investors are seeking market exposure and genuine diversification
- 2020 outlook: Investors should not generalize instead scrutinize the real source of managers' performance.
For the last 15 years, then alternative investments have been rising in popularity. Many investors have started looking beyond traditional assets in the search for diversification and higher returns.
BCG Consulting Group, in its recent study, showed that AUM in alternative assets has been rising faster than any other investment category, except the passives.
Active exposure to alternative investments provides diversification, especially in times of market stress.
However, it’s important to remember that alternative investments are not a cohesive group, and one size fit all approach won’t work.
If you are considering alternative investments, then you need to do your homework and carry out the appropriate due diligence when selecting the most suitable option.
Investors are seeking market exposure and genuine diversification
Alternative investment managers rely on market exposure to generate returns, but market exposure does not protect against a downturn.
Take an example of private equity. A recent study by Brigham Young University used secondary market transaction data to look deeper into the sources of returns.
The research found that private equity has delivered high equity beta and low alpha, meaning it has been highly sensitive to market volatility and not delivered excess returns.
The historically high total returns associated with private equity investments and buyout funds have originated from extremely high debt levels, hence the market correlation.
That said, genuine diversification is possible, and some managers have been able to deliver value-added alpha.
However, the beauty of alternative investments lies in the variety. You can genuinely benefit from strategies that invest across a varied suite of alternative risk premia and hedge fund strategies, rather than relying on equity beta.
Over time, alternative investments should be able to provide near to zero percent net exposure to traditional equity and fixed income markets.
The strategy is a proven approach. The HFRI Indices show that a strategy based on lower equity beta (less than 25%) has proven beneficial.
We are heading to 2020; the markets are vulnerable to shocks, especially in the corporate sector.
If buyback-fuelled equity growth slows due to rising corporate finance costs and declining margins, then we could quickly enter into the realm of bear market dynamics.
In this context, combined with the current state of fixed income markets, there is real value in adding diversifying sources of returns.
Also, while potentially timely given the current market conditions, this is an approach with long-term merit.
However, investors should not generalize instead scrutinize the real source of managers’ performance.
Only by looking under the carpet can they ensure they align their investment goals with the strategy they select.