A large majority of UK financial professionals believe that the current economic climate is conducive to investing in alternative asset classes as they provide diversification for investors in a complex environment, but not all agree.
According to research by TIME Investments, 96% of wealth managers, financial advisers, discretionary fund managers, fund selectors and investment analysts have allocated some of their clients’ money in alternative investments such as private equity, private credit, hedge funds, infrastructure and real estate.
Yet the team at west midlands-based discretionary fund manager ebi Portfolios purposefully avoids alternative asset classes, building its model portfolios exclusively with conventional asset classes.
Investment product manager Jonathan Griffiths explained that he does not believe there is “long-term value to be added through alternative assets”.
An asset class he is particularly worried about is property, and more precisely commercial property, although ebi used to have a separate property allocation in its portfolios.
He explained that this asset class is highly dependent on leverage to fund acquisitions. Yet, interest rates have rapidly surged from very low levels to the 5% range in the US, UK and EU, with borrowing becoming more expensive as a result.
Griffiths said: “The day of reckoning has been delayed as some more deals have been done and short-term patches have been applied, but I think it's going to be clear over the coming months and quarters that property, especially commercial property, is a very painful place to be.
“The extent of the write-downs of property has become apparent following the interest rate hikes. That's going to be an interesting asset class to watch, but unfortunately, not in a positive way.”
Another alternative asset class Griffiths is sceptical of is private equity as the current macro-environment is not favourable to unlisted companies. He pointed at the unhealthy state of the IPO market, the difficulty to exit positions and the fact debt refinancing has become much more expensive.
He said: “I don't have a crystal ball, but we could see some pain in the private markets over the coming months and quarters. There might be some deep default waves that would feature a lot of private equity-backed companies with high debt driven models.”
“A lot of the high returns we have seen in the private equity space was levered up through the cheap money era. That's over now and it's time to face reality.”
Independently of the macroeconomic environment, Griffiths does not like the opacity of private equity firms as it leads to massaging the figures, both in terms of volatility and returns over time. Therefore, he believes that public equities have always been and remain a “far safer” proposition.
Griffiths said: “When you're looking at a longer term timeframe, equities are the better value driver and that's what's driving the growth in our portfolios.
“We use bonds to provide the protection aspect with a tilt to shorter durations to reduce interest rates risk. It has been the right decision over the last few years.”
Michael Heapy, senior investment analyst at IBOSS, part of Kingswood Group, agreed that the outlook for commercial property is bleak as it is hard to imagine “people going back to department stores and malls” or “flooding back in numbers in an office environment”.
Yet, he disagreed with the exclusion of alternative asset classes from portfolios, reminding that equities and bonds fell in tandem in 2022.
He said: “Given the falls we saw in equities and bonds last year, alternative assets are increasingly important in ensuring a client's portfolio remains diversified during challenging market conditions.
“That said, the rearview mirror is a dangerous investment aid and bond markets, in particular, have a better risk-return profile than they have had for many years.”
Other wealth managers also believe that now could be an attractive entry point in private equities for long-term investors, but warned that they have to be selective with the firm they want to invest with.