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Alternative Investments Market Commentary Q4 2019

29 November 2019

"Private capital is increasingly open to the 'unconventional' " says Claire Madden, Managing Partner, at Connection Capital.

  • Mainstream market volatility prompting a re-think of asset allocations
  • Growing recognition that alternatives offer suitable strategies for all scenarios
  • Illiquid assets counterbalance higher weightings of cash

As the decade draws to a close, the much hoped-for end to economic and political uncertainty remains elusive. Whatever the outcome of the upcoming UK general election in a few weeks’ time, Brexit negotiations will be far from over even if a divorce deal is done, interest rates are unlikely to “normalise” any time soon, and public market volatility shows no signs of settling down. Against this backdrop, alternative assets are coming into their own as investors seek new sources of returns to increase resilience and boost performance in their portfolios, by diversifying across an even broader range of asset types.

Asset allocation under review

Such tactics may be nothing new for institutional investors, but in the past year or two, interest from private capital (high net worth individuals and family offices) has shifted up several gears as awareness has been raised and access opened up. It’s no co-incidence that more than half of Connection Capital clients responding to our survey decided to up their allocations to alternatives last year, with over a third planning to do so in the next 12 months. Current conditions demand a more radical approach.

Investors are increasingly realising that one of the key benefits of alternative assets is that there is a strategy for all occasions. Since this is not one single asset class but an umbrella term for a variety of investments, from unquoted SMEs to private credit, litigation funding to infrastructure funds, real estate to fine art, returns potential can exist in any market environment. Now more than ever, the sense of balance that including a range of alternatives can give to a portfolio, in order to mitigate market cycles in other more mainstream asset classes, is achieving the recognition it deserves.

As investors reduce their weightings to quoted equities and bonds, traditional portfolio composition is changing in unprecedented ways. Many investors are going long into cash so that they can capitalise quickly on good opportunities when the time is right, for instance, by buying back in when markets hit bottom. At the same time, investing in alternatives is a way to off-set this extremely liquid position by building up assets with long-term investment horizons.

The case for illiquidity

Participating in closed-ended structures can be a way for investors to insulate themselves against the irrational behaviour of others. Even better, if there is yield-generation attached or an “illiquidity premium” to be gained from tying up capital for longer. For example, latest BVCA figures show that annual returns on private equity were 18.5% p.a. over the last five years compared to just 4.1% for the FTSE All-Share. When looking at 2018 in isolation (the most recent year of data), the difference is even more stark: 15.6% versus -9.5% . No wonder investors are becoming more open-minded to the “unconventional”.

FX as a diversifier

Alternative assets that are denominated in other currencies are also coming into focus. Though a certain degree of hesitancy around foreign exchange persists, in fact it can be an essential part of diversification strategy – especially now. It’s a classic hedging position: if one currency weakens, another will strengthen. Surely something to consider as Brexit continues to weigh down sterling.

We don’t think growing demand for alternative assets is a transient trend. There will always be an important place in private investors’ portfolios for stocks and bonds, but appetite for alternatives, once whetted, is unlikely to disappear. Looking forward into 2020, issues like the continued availability and generosity of tax reliefs could play a part in decision-making but fundamental investment principles should remain firm. Alternatives have a critical role to play as a diversifier and driver of potential returns, whatever the future holds.

Claire Madden, Managing Partner - October 2019.

 Russell O'Connor
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