“Concerns around non-performing loans in private debt, as well as general risk aversion and a greater focus on the path to profitability in early-stage investing have also impacted on the relative attractiveness of investment strategies that would fall into the ‘alternative’ camp.”
Based on its own historical analysis, Morningstar says that, among hedge funds, managed futures tend to perform better than other alternatives and conventional assets such as cash and bonds in phases of accelerating and high inflation.
However, commodities have been the best assets to hold in these environments. During phases of inflation being above its five-year average, global macro funds have historically performed better, along with gold.
Nicolo Bragazza, associate portfolio manager at Morningstar Investment Management, notes that when the US Federal Reserve has raised rates, historically, hedge funds have performed better than bonds and cash, but not necessarily better than equities.
Bragazza says: “During the taper tantrum [in 2013], equities performed significantly better than most hedge fund categories and it is not surprising to see long/short equities as the best performers among alternatives, given their higher sensitivity to equity markets.”
According to Nick Hyett, investment analyst at the Wealth Club, certain alternative asset classes, like real estate, forestry and infrastructure, should perform better when inflation is high, since revenues are generally inflation-linked.
However, the significant amount of debt they hold has been “a drag” recently, and if rates continue to shoot up that could continue.
Hyett notes: "The old investment maxim that it’s 'time in the market that counts, not timing the market' applies."
“Guessing the 'best time' to invest in alternative assets is somewhere between difficult and impossible. Instead, investors should build a broad portfolio that can weather a wide range of market conditions.”
Diversification benefits
With the continued high interest rate and inflation, alternative assets (from infrastructure, renewables, private equity and private credit, to very specific strategies such as music royalty finance) are being used even more to offer portfolio diversification.
What drives performance in these investment classes is likely to be different to more traditional equities and fixed income portfolios.
“Infrastructure, for example, provided investors with returns that are non-correlated with the wider macro environment, inflation-linked and backed by physical assets delivering critical services providing strong downside protection,” says Phil Kent, director and member of the investment committee at Gravis Capital Management.
In the venture capital trust market, returns are based primarily on revenue growth at young, disruptive companies.
