Experts that spoke to Investment Week for our Deep Dive explained that alternatives, while not a silver bullet, offer investors an effective diversifier that can be worked into a full portfolio.
A new macroeconomic regime
Investors cannot rely on their knowledge of the recent past to guide their investment decisions and must think harder about diversification and resilience than before.
Xavier Baraton, global chief investment officer at HSBC Asset Management, explained that we are now entering a "new macroeconomic regime", which will be characterised by persistent inflation, higher interest rates and volatile economic cycles.
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"So far this year, markets have been going through a series of stress tests," Baraton explained. "Geopolitical tensions, high inflation and policy tightening led the performance of most asset classes on a turbulent ride into negative territory.
"We do not think current market volatility solely reflects investors' risk aversion. We think it also captures something longer-term than the uncertainties associated with the current short-term, cyclical outlook."
Baraton added that the positive correlation of stocks and bonds marks a "significant paradigm shift" that impacts his approach to diversification, shining a spotlight on alternatives and defensive assets.
"This situation supports the case for real assets and other 'new diversifiers' that can continue to deliver solid diversification while increasing portfolio resilience."
Investment trusts
For Richard Parfect, fund manager at Momentum Global Investment Management, investment trusts are the vehicle through which to invest in alternative assets, particularly real estate and infrastructure.
On a risk/return profile, alternatives sit between equities and fixed income, according to Parfect, arguing it is less volatile than stock markets but offer a higher return than fixed income, which is often linked to inflation.
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"At this time of soaring inflation and the risk of a prolonged stagflationary environment, we are seeing the benefit of those defensive qualities of our alternative investments," he said. "Many have a positive linkage to inflation and its current causes such as high energy prices are benefiting the renewable energy trusts.
"Similarly, our real estate investment trusts are seeing strong rental growth across various sub-sectors such as logistics and industrial warehousing to life science companies as globalisation (a deflationary force for years) has been replaced with re-shoring and companies moving to a ‘just in case' business model that requires more resilience."
However, Parfect caveated that investment trusts carry their own risks as they can trade at a premium or discount to their underlying net asset value, leaving them open to the whims of market sentiment.
"So long as that is appreciated and holdings are sized accordingly, then market risk can be mitigated," he said.
Renewable energy
It is time for the US solar market to shine, said Whitney Voûte, head of investor relations at US Solar fund, who argued the market is more appealing than that of Europe, with volatility again a key factor.
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"We would not invest in projects or markets with more volatility - this is certainly true of some emerging economies or market structures where market growth may be compelling but unpredictable regulatory markets increase risk," she said.
"However, increased volatility is also a part of some more developed markets like Europe and the UK. Russia's invasion of Ukraine has, sadly, highlighted the challenges of investing in markets which are reliant on imported energy.
"While the rollout of renewables in Europe runs ahead of penetration in the US (highlighting for us the US opportunity), European electricity production remains very dependent on imported fossil fuels, causing power-price volatility."
Voûte added that power prices in the US also hold greater stability than elsewhere, arguing this provides investors with the consistent income they seek.
She continued: "PPAs in the US tend to be long in tenor (ten to 25 years)… and these provide strong steady cashflows to support dividend payments."
Diversification and uncorrelated returns
Alternative investments is a broad space with many intricacies that investors new to the space will have to wrap their head around.
Scott Thompson, senior investment analyst, Morningstar Investment Management Europe, noted that while many funds in the sector offer the diversification and uncorrelated returns that are often touted, not all products meet this expectation.
For example, private equity funds have performed similarly to large-cap global growth funds year to date.
If investors are seeking diversification, Thompson recommended the WisdomTree Enhanced Commodity ETF, offering investors broad exposure to the commodity market, including the typical oil, gas and gold, but also corn, wheat, copper, coffee, cattle and lean hogs.
He added that commodities can often be volatile, and having seen sharp gains recently could well be on track for a sharp pullback, but succinctly made the case: "The easiest way to hedge against inflation is to buy the stuff that is causing it."
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For those after an uncorrelated return, Thompson pitched BSF Global Event Driven, which aims to capitalise on mergers and management changes.
The best returns from mergers can often be found in downturns, which will provide investors a positive return when other elements of their portfolio are falling.
"This fund has a depth of resource and access to management that stands out against peers and has delivered positive absolute returns since inception in August 2015 with a beta of around -0.1 to the S&P 500, according to Morningstar data," he said.
Finally, for investors who are seeking to diversify their income, Thompson suggested the Supermarket Income REIT, arguing that the case for supermarkets is "compelling".
"Supermarkets generally have longer leases than normal commercial property," he said. "Think of your local big supermarket - chances are it has been there a long time.
"The rents also come with inflation uplift, to protect against the current environment. Apart from a quickly reversed fall in share price in 2020, drawdowns are generally limited and the fund delivers an attractive yield of around 4.5%, according to Morningstar data."