Alternative investments a must for the modern portfolio

Alternative investments a must for the modern portfolio


Sunday, October 25, 2020

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ALTERNATIVE investments have been creating quite a buzz in the financial market as investors contend with the effects of a global pandemic, geopolitical risks, and the resulting impact on the performance of traditional assets such as stocks and bonds.

This roller coaster experience in traditional asset prices caused by the aforementioned factors is expected to become the new normal but has negative implications for long-term financial goals.

As a result, the search for investments in assets in non-traditional spaces, which have exhibited relatively low correlation to stocks and bonds, has intensified. When additional benefits such as the potential returns, steady income stream, and inflation hedge are considered, alternative investments have become a staple for investors in this day and age. Historically reserved for institutional and high net worth investors, alternatives are now considered a core portfolio holding.

Alternative investments may include hard assets such as commodities, currencies, infrastructure projects, vacant land and developed real estate/real estate investment trusts (REITs).

They may also include a group of assets professionally managed in a non-traditional format. These investments can deliver returns from different drivers and in different patterns than traditional stocks and bonds. As a result, there are significant diversification benefits when included in a standard portfolio.

Stronger diversification offers the benefits of potentially generating attractive returns, reducing volatility in a portfolio for a smoother and less-stressful investment experience, while preserving capital over a longer-term horizon. For investors with the appropriate risk tolerance, alternatives offer the potential to earn higher returns and act as an inflation hedge.

The 20-year average annualised returns of REITs and gold were 9.9 per cent and 7.7 per cent versus 5.6 per cent and 4.5 per cent on stocks and bonds, respectively. Moreover, given that infrastructure and other physical assets such as real estate, once built, exist for generations, and the contracts underpinning the provision of infrastructure services tend to be long term with predictable revenue streams, investors stand to benefit from this steady income stream.

That said, these asset classes usually require high minimum investment and advanced technical competencies to assess their attractiveness. As such, they are primarily held by institutional investors such as pension funds and ultra-high net worth investors.

Global alternative assets under management reached nearly $US10.1 trillion in 2016 and are expected to grow to US$21.1 trillion in 2025, underpinning a fundamental shift towards alternatives by many sovereign and public pension funds.

In April 2015, for instance, the world's largest pension fund, the US$1.1-trillion Government Pension Investment Fund (GPIF) of Japan, announced a new strategic asset mix in a bid to achieve higher returns and address the needs of an ageing population. Significantly, GPIF's new mandate allows for a five per cent allocation to alternatives, representing a significant opportunity for alternative firms .

In North America, the Canadian Pension Plan, for example, holds over 50 per cent of its net investable assets in alternatives. Although the trend has started with larger institutional investors in developed markets, alternatives will increasingly occupy a prominent allocation in the world's economies, both established and emerging.

Having been traditionally a Government fixed-income instrument-reliant investor base, declining interest rates brought a shift to the Jamaican investment landscape in the last decade as investors turned to the stock market in search of higher-yielding assets.

Up until two years ago the Jamaica Stock Exchange (JSE) was riding on a high, having copped “best-performing stock market” by Bloomberg in two of the last five years. Fast-forward to 2020, the year of the great pandemic, earthquakes, geopolitical tensions and elections (just to name a few), the tables turned once again.

While the general expectation is for a recovery in the stock market, we can agree that bouts and dips will become the new norm and as such, local investors must now consider other assets that will help them stay afloat even in uncertain times.

Markets are now more volatile than ever and investors need better ways to grow their wealth while effectively managing risk. Alternative investments can be key components in portfolios for all investor types – providing diversification benefits and reduced volatility and thereby helping investors achieve their goals. While the high minimum investment and difficulty in assessing these investments may prove challenging, particularly for local retail investors, collective investment schemes such as mutual funds should be considered for these exposures.

In addition to the lower minimum requirement relative to an outright purchase of the asset, mutual funds provide access to a wider range of assets that fit within a particular theme and management, with the requisite skill set to assess the attractiveness of the individual investments. Given the benefits outlined, it is safe to say that mutual funds will be the vehicle that drives alternative investment assets in the retail investment mainstream in the not-too-distant future.

Simone Hudson is the assistant vice-president, alternative investments & fund management at NCB Capital Markets Limited.

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