It’s no secret that alternative assets - a catchall phrase for anything outside the major stock, bond and cash markets - are becoming increasingly popular. Historically low interest rates and the enduring effects of stimulus programmes are making both bond prices and global equity markets look expensive, and particularly vulnerable in the context of inflation.
Alternatives are attractive because they have tended to have a low correlation with public equities and bonds, and exposure to real assets should benefit from a rise in global price levels. The difficulty for private investors has been access, as by their nature most alternatives have poor liquidity. But a growing number of specialist investment trusts in the private equity, infrastructure and real estate sectors are a good way for you to invest.
There are consultations on pension policy underway that seem to vindicate the case for alternatives. In the March budget, Chancellor Rishi Sunak suggested emerging sectors such as green infrastructure and innovative British companies as a good fit for the long-term horizons of defined contribution (DC) pension schemes, as spelled out in preparations for the Long-Term Asset Fund, designed to encourage more investment in alternatives.
The Department for Work and Pensions is currently drafting regulations which would allow DC schemes to smooth the incurrence of performance fees, which are often payable on illiquid investments, over five years. The hope is that this will give trustees, especially those who are unsure about investing in illiquid assets, the confidence to make that leap “safe in the knowledge that they can deliver the best possible return for their members” - according to a ministerial foreword.
Some defined benefit (DB) schemes have come out in defence of owning alternatives, following more cautious regulatory guidance. As the pensions watchdog became increasingly concerned about the liquidity of some DB schemes, particularly following the challenges of last year, it suggested that governing bodies should ensure no more than a fifth of scheme investments are held in assets not traded on regulated markets.
In a follow up blog post, the regulator said that this expectation has caused concern among a number of schemes, some of which have up to half of their assets in unregulated investments. The regulator is now considering what adjustments to make.
Both these examples nicely illustrate the potential risk and reward of owning alternatives. They can be costly and hard to access, but they might also offer real returns in the long term and a way to diversify a portfolio.
“With sovereign and corporate bond markets offering little in the way of yield, investors have had to look to alternative assets to try to dampen down equity volatility,” says Edward Park, chief investment officer at Brooks Macdonald.
Since the start of 2021, his team have reduced fixed interest exposure and increased their weighting to convertible bonds, infrastructure assets and commercial property.
The attraction of infrastructure investment trusts has not gone unnoticed, with these trading at an average premium to net asset value (NAV) of 14 per cent, according to broker Winterflood. A number of private equity investment trusts, however, are trading at double digit discounts despite strong NAV performance.
Alternative investment trusts require a long investment horizon as their share prices can experience volatility. A number of investment firms suggest a portfolio allocation of between 5 and 20 per cent to alternatives for private investors.
