An Introduction to Alternative Investments and Their Impact On Returns

Historically, alternative investments (alternatives) have been considered a viable investment strategy, as they invest across asset classes and regions, have different characteristics, and behave differently from traditional investments.


 Alternatives  have increased since the 1990s due to institutional investors, endowments, and pension fund demand. We have also seen a growing interest from high-net-worth investors seeking diversification and returns benefits.  


Some of these alternative investments could be more efficient in protecting purchasing power against inflation and have the potential for higher returns relative to a conventional asset allocation comprising of equities and fixed income.


                                                                            Alternatives Fundraising

Source: Preqin, J.P. Morgan Asset Management. Fundraising categories are provided by Preqin and represent their estimate of annual capital raised in closed-end funds. Data may not sum to total due to rounding. *Natural resources include natural resources and timber funds. 2021 fundraising figures are as of May 2021. Data is based on availability as of May 31, 2021.


While traditional alternative investments, such as commodity and real assets have performed well in an inflationary environment, other investments, including private equity, hedge funds, and real estate are also worth considering.  This is particularly timely if you are concerned about inflation, market volatility, and low yields.


Market participants have largely considered alternatives in seeking to diversify their portfolios and potentially yielding higher returns.


Institutional investors may choose to allocate assets in alternatives to add non-correlated assets to their portfolios to reduce overall volatility.


                                                                     Equity Market Correlations and Yields
Equity Market Correlations and Yield

Source: Bloomberg, Barclays, NCREIF, MSCI, FactSet, ICE, J.P. Morgan Asset Management. Fixed income shown above are represented by Bloomberg indices except for EMD and ABS – U.S. Aggregate; MBS: U.S. Aggregate Securitized – MBS; U.S. corps: U.S. Corporates; Munis: Muni Bond 10-year; U.S. HY: Corporate High Yield; TIPS: Treasury Inflation-Protected Securities (TIPS); Floating Rate: U.S. Floating Rate; Convertibles: U.S. Convertibles Composite; ABS: J.P. Morgan ABS Index; EMD ($): J.P. Morgan EMBIG Diversified Index; EMD (LCL): J.P. Morgan GBI EM Global Diversified Index; EM Corp: J.P. Morgan CEMBI Broad Diversified Index; Euro Corp.: Euro Aggregate Corporate Index; Euro HY: Pan-European High Yield Index; U.S. Real Estate: NCREIF Property Index – ODCE ; Europe Real Estate: Market weighted-avg. of MSCI Global Property Fund Indices – U.K. & Cont. Europe; APAC Real Estate: MSCI Global Property Index – Asia-Pacific; Global infra.: MSCI Global Quarterly Infrastructure Asset Index (equal weighted blend; U.S. Direct Lending: Cliffwater Direct Lending Index; Convertibles yield is based on the U.S. portion of the Bloomberg Barclays Global Convertibles. Country yields are represented by the global aggregate for each country. Yield and return information based on bellwethers for Treasury securities. Correlations are based on quarterly return over the past 10 years through 3/31/2021, except Direct Lending, Infra, and U.S., Europe, and APAC Real Estate, which are through 12/31/2020. International fixed income sector correlations are in hedged U.S. dollar returns except EMD local index. Yields for all indices are hedged using three-month LIBOR rates between the U.S. and international LIBOR and are a 12-month average. Alts yields are through 12/31/2020. U.S. Real Estate yield is calculated using the MSCI Global Property Fund Index -North America. Data is based on availability as of May 31, 2021.


For example, a defined benefit plan, whose liabilities are sensitive to inflation might benefit from real assets to reduce asset-liability mismatch. Market participants may consider alternatives based on their overall goals and objectives.  If they are susceptible to cash flow and income generation, they may lean more toward private credit, high yield, or real estate.



                                                                    Hedge Fund Strategy Returns
Hedge Fund Strategy Returns

Source: MSCI, Bloomberg Barclays, HFRI, FactSet, J.P. Morgan Asset Management. Global equities reflect the MSCI AC World Index and global bonds reflect the Bloomberg Barclays Global Aggregate Index. All hedge fund returns are from HFRI. HFRI Composite: HFRI FW Composite Index. Returns may fluctuate as hedge fund reporting occurs on a lag. Please see disclosure pages for index definitions. Data is based on availability as of May 31, 2021.


In considering alternatives, market participants should consider the benefits as well as some of the drawbacks.

Most of the traditional options are intuitive to understand and track. For instance, selecting an inflation-linked bond fund to mitigate against inflation risk in a portfolio is relatively straightforward to assess and monitor over time.


However, we should recognize that the regulations, transparency, fees, and tax considerations can be vastly different. Therefore, we need to clearly understand the liquidity provisions along with the operational and reporting complexities.


An investment consultant can assist with the investment decision process and due diligence. The key considerations are the fund manager’s track record, investment strategy and philosophy, fund size, fee and liquidity structure, and eligibility.

While not all alternatives are for everyone, not every alternative has similar returns. Therefore, there is a need to be diligent with manager selection, as only a few of them have the consistency to discover and invest in innovative companies in the private market.


Ryan Lord, Vice President at CAIS Group, noted that “a selective group of alternative’s managers consistently perform in the top quartile.”


In addition, for several investors, alternatives can be a tax-efficient strategy as they could qualify for nonrecognition of gain or loss under section 1031 of the IRS Code:


                                                                Hedge Alternatives and Manager Selection

Sources: Lipper, NCREIF, Cambridge Associates, HFRI, J.P. Morgan Asset Management. Global equities (large cap) and global bonds dispersion are based on the world large stock and world bond categories, respectively. *Manager dispersion is based on the annual returns for global equities, global bonds, and U.S. core real estate over a 10-year period ending 1Q 2021. Hedge fund returns are based on annual returns from Feb. 2011 – Jan. 2021. U.S. non-core real estate, global private equity and U.S. venture capital are represented by the 10-year horizon internal rate of return (IRR) ending 4Q 2020. Data is based on availability as of May 31, 2021.

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