Exploring Alternatives
The term “alternative assets” refers to non-traditional investments that fall outside the familiar realm of stocks, bonds, and cash. They include asset classes like hedge funds, commodities, real estate, as well as investments in private companies.
In a recent briefing note, UBS stated that investors could consider replacing around 20-40% of their exposure to public markets with alternatives, depending on their specific circumstances.[3]
What makes alternatives ‘alternative’? There are many answers to that question, but a key difference is that alternative asset managers typically target ‘alpha’. In common parlance, this refers to ‘beating the market’ (or ‘beta’).
When the market is set to become more volatile or in danger of low growth, exposure to alpha can not only improve returns but also lower volatility, as returns are less correlated to the market overall.
Within alternative assets is a sub-group of investments called ‘private markets’.
Private markets investing involves buying or lending to companies that are not traded on the stock market. Like other alternatives, it can help investors benefit from the advantages of “alpha”. Unlike trying to outsmart fellow stock market investors, it is a way of side-stepping the competition and seeking out opportunities in pastures new.
Private Equity
As we’ve covered in previous articles, investing in firms directly has numerous benefits during a period of market volatility. Holding periods are typically longer for private equity (around 5-7 years), which shields investors psychologically from the ups and downs of the stock market.[4]
From a statistical perspective, there are many more private companies than publicly listed ones, and hence a greater chance of finding an investment with upside potential.[5] Private ownership makes it easier to capitalize on value-creation opportunities, as one has access to management and likely influence on the board.[6]
Furthermore, since many promising companies in growth sectors (e.g. AI-related infrastructure, health, and climate-related solutions) are at a relatively early stage, they are typically accessible only through private investment.
Private Debt
Private debt, or private credit as it is also known, has various advantages compared to public fixed income. Private lending has typically yielded higher returns than public debt over the past decade (3-6% over public high yield and broadly syndicated loans)[7], as the companies who seek debt in the private markets often have specific needs or risk profiles that banks or the public markets cannot or will not serve.
It also is normally less volatile than public debt with similar risk ratings.[8] As with private equity investments, private debt is less exposed to the effects of shifting investor sentiment and speculation by traders.
If private equity provides growth potential through value creation, private debt can help bolster the income streams of a portfolio, making it more liquid and overall returns more stable.
Conclusion
Private market investments and alternatives in general can offer valuable strategies to manage rising volatility and pressurized returns in the public markets.
The difficulty is knowing which private deals to invest in. The upside potential of a good private company is only valuable if the management team executes effectively. Similarly, lending outside the mainstream channels requires thorough due diligence to mitigate risk. Amid still-elevated interest rates materially altering the lending landscape, diversification becomes even more critical by incorporating the right mix of alternatives alongside traditional assets, investors can better manage risk and enhance portfolio resilience.
The inherent complexity of private market investments is why they have typically been restricted to high-net-worth individuals. Recently, however, firms like The Family Office are leveraging technology to democratize access to private markets, meaning that investors can access both the opportunities themselves and the expertise to maximize them.
When times are good, it’s a good time to explore alternatives.
For further discussion or guidance, feel free to contact us.
[7] Goldman Sachs