Don’t believe TINA: There are alternatives
The expression ‘TINA’ (There Is No Alternative) has reached meme status in recent years as high prices in almost every asset class have left investors frustrated. With cash rates well below the level of inflation, sitting out of the market is not a desirable option either. Hence, with a seeming lack of alternatives, investors have piled into equities, cryptocurrencies, and more recently, even NFTs.
But the irony of it all is that alternatives have been staring investors in the face the whole time. By which I mean the asset class called alternatives.
Alternatives is a catch-all term that covers all non-traditional assets, from art to volatility, and everything in between. As David Wright, CEO of Zenith Investment Partners, and Kerry Craig, Global Market Strategist at J.P. Morgan Asset Management explain here though, there is a slightly narrower subset of these they focus on. They include private equity and debt, hedge funds, and real assets such as real estate and infrastructure.
In this roundtable discussion, Kerry and David explain where alternatives sit in an investor’s portfolio, some of the risks and downsides, and why investors are making the switch today. We even discuss whether crypto assets are attractive as alternatives.
Consider the alternatives beyond traditional assets
In part 1 of this interview, Kerry and David talk about current market conditions and why they’ve created an ideal situation for alternatives. They will be discussing how to use alternatives to achieve your investment goals in our upcoming webinar ‘Alternatives – how to use them and why the right time is now’ on Friday, 10 December. Register here.
Find out more about J.P. Morgan Asset Management's Alternatives capabilities.
Could you explain what alternatives actually are and where you see them fitting into investors' portfolios?
An alternative is basically anything that's not a stock or a bond. I mean, it's just so wide. It could be commodities, it could be art, it could be fine wine.
For us, we narrow it down to things like private equity, private credit, real assets. So that's infrastructure, that's real estate, that's transport. And we're also thinking about things like hedge funds.
Those are the big buckets when we think about alternatives for most investors today; not really commodities or other things.
How you put them in a portfolio is really going to vary according to your objective. Are you looking for income? Are you looking for growth? What are they meant to do?
Because if you break down the characteristics of each of those alternatives, some will fit in specific areas.
A core real estate asset might offer a very good level of income and diversification. That's going to fulfil the role of some fixed income.
If you're looking for growth, maybe that's more private equity, and that's going to go something like equity in terms of replacing your portfolio.
It becomes about what you're trying to achieve in your portfolio, the characteristics, to how you dissect them, or the lens you look through to look at equity markets or bond markets and how you get that from private markets.
It's not a case that you take out one thing from your portfolio and put alternatives in. It's more about how can they complement or supplement what you already have.
I completely agree. We've tended to allocate alternatives within the growth allocation of portfolios.
And as I mentioned before with Your Super, Your Future, the direction there is to split portfolios between defensive and growth.
Some groups already do that. We've tended not to, because of the complexity, because of the volatility. And generally, we've found there hasn't historically been much appetite for low growth, low volatility alternatives.
As you said before, Pat, that's changing, with the limited ability of traditional fixed income assets to provide for both income and defensive qualities.
I think as Kerry says, it's horses for courses. Alternatives are very different across a different spectrum and will fit in different parts of your portfolio, according to what your objective, and income and growth requirements, are.
The temptation might be to put 100% of your portfolio in alternatives. Why might you not want to do that? What are some of the risks or disadvantages that come with alternatives?
That would be an interesting problem to have. We've got the opposite in that we've had such strong equity markets for such a long period of time.
People are saying, "Well, why do I need alternatives?" And those that have had alternatives have said, "Well, they're not keeping up, so should I get rid of alternatives?" I think the reason you wouldn't have a full portfolio of alternatives is exactly that.
Very few, if any, alternatives are designed to keep up with equities, particularly in bull equity market periods. That's just not going to be the case.
We talked about before, the importance of diversification and having assets that don't correlate or behave the same. There are some alternatives that behave quite similar to each other. So you want traditional assets in the portfolios as well.
There are things like we spoke about — some of the complexity. Complexity, lack of transparency and understanding of what the manager or product is actually doing have kept people away from alternatives. And I think that's a legitimate reason why you wouldn't have 100% allocation to alternatives.
And again, liquidity. Some of the alternative assets are not liquid. I don't think you would want a portfolio of 100% less liquid assets.
So there's a range of reasons you wouldn't go holus-bolus into alternatives. But, equally, what we are seeing is that alternatives are very much underrepresented in portfolios, particularly given what we see as being a pretty uncertain investment outlook going forward.
Not to step on your toes here, David, but there's also the access issue. Even if you wanted to, say, pile into alternatives, there are absolutely definitely liquid alternatives you can get into very easily.
Some of the strategies that David talked about before, but on the more illiquid side, obviously you have things like minimum thresholds for what you can invest that could lead to concentration risk in your portfolios.
Access to managers might be different if you're a very small investor, compared to a large thing, because these have largely been the realm of institutional investors for a long time.
I think access is improving, but slowly. New vehicles are coming through, but this is the area where I think you're going to see the most development. Like how do smaller investors actually access these attributes of alternatives?
What about crypto? Where does that fit into all of this? It seems as though it's starting to be viewed as an alternative asset of its own. Some people say it has a relatively low correlation to equities, but others disagree. Where does crypto fit in, if at all?
Crypto comes up all the time with clients. Should they be investing in it, what the outlook is for it. There is still a big question mark over that. Will it become more regulated and what that means.
Crypto is a relatively new asset class. So drawing on history to figure out how its correlation works with other parts of the public market, or even private markets, is difficult.
If you do just look at history and say is it correlated to equities, overall it says no. It says this is an asset that could be a diversifier.
The difference is, depending on what time period you look at, it is correlated with equities. Sometimes it behaves as a defensive asset and goes up when equity markets go down. Other times it's the complete opposite and it goes up when equity markets go up.
So, the correlation can change over time. And I think that's the difficulty for investors. It is a highly volatile asset.
The correlations aren't certain and proven yet. I think it is so volatile — if you put that into your portfolio, think about what it does to portfolio volatility. Your allocation to it might end up being very, very small.
It's one for watching for us. But I think that there are those question marks, which I think really restrict it in terms of the portfolio construction concept for now. David might have a completely different view.
No, I completely agree with Kerry. I think it is interesting. It gets a lot of media attention.
There have been some sensational returns reported, but equally, as Kerry said, it's very volatile. And we know that in market drawdowns, even in equities, people will tend to lose their nerve and get out at precisely the wrong time.
So the crypto ride, if you like, is in magnitude much greater than that of the share market. It certainly is not for the faint hearted.
At the moment, it's more the domain of probably private and retail investors, and institutional investors are not there yet, for the reasons Kerry mentioned.
It's not a regulated or heavily regulated asset class yet, so that brings in additional risks. But it's interesting.
Was it just yesterday or the day before we had a crypto ETF list on the Australian market and record turnover? Clearly, there's a lot of interest.
There's a lot of people thinking this is a chance to make some huge bucks. Sadly, that's not going to be the case for everybody.
Rates have been low for quite a long time now. What effect has this had on equity markets?
It has had really two effects because bond yields are low. You think something like a 10-year bond, it's the benchmark; it's the risk-free rate for pricing off every other asset.
And so when those yields are low and those prices are very high, when you look at other assets, they suddenly look more attractive. And this has the effect of pushing people towards other assets when they're looking for something to either provide income or returns for their portfolios.
And you may have heard the phrase, there is no alternative. Well, clearly there is, because we're talking about alternatives today.
But for many investors who stick to the public markets, they are just being pushed further and further into equities. And so it creates that valuation gap that keeps widening as long as those yields are low.
And the secondary fact is when you buy a stock, when you buy a company, what you're effectively buying is future earnings.
And you need to discount those future earnings back to today to figure out the value of the company.
If those yields are low, it affects how we discount those rates. That's why there's some sensitivity. If we think about markets today, bond yields rising, anything that has a really high valuation on it, and those discount rates change, it can make that very much unappealing.
It has the possibility to create a bit of distortion and too much money flowing into one area of the market — financial instability.
It's something central banks have been aware of for a while now, as they've gone into other areas. But I think that the valuation relative to other assets is one of the bigger factors.
Kerry's right. There's a real stretch in hunger for income. We're getting very little on cash in term deposits at the banks.
So with the population bulge, the ageing demographic we've got moving through the system, there's a lot of people in retirement, a lot of people drawing down on their superannuation and wanting income to support their living.
That has led to people that may not have invested in the stock market before chasing high-yielding stocks. And that in itself is not necessarily a bad thing, but there's obviously volatility in stocks.
Whereas if they're used to being cash and fixed interest investors — well, at least term deposit investors — there isn't that volatility.
That actually agrees with the experience we've seen at Livewire over the last few years as well. Four or five years ago, most people were primarily interested in equities and bonds.
These days it seems as though a lot of people are searching for income in alternative places. It seems as though it's not just at your end.
It seems as though it's the broader retail audience that is really starting to generate interest in these kinds of investments.
Absolutely — that doesn't surprise me. I think the issue is that there has been this stretch for yield, stretch for income.
Some of the assets that are providing those high levels of income, you've needed to go out on the risk spectrum to generate that.
And unfortunately, not all investors understand the extra risk they're taking on to get that income. So it's all been good until it's not.
That's the concern we have, that people don't fully understand the risks they're exposing themselves to in chasing those kinds of high yields.
That's absolutely right. If you think about the shift across the credit spectrum, as you move from something that's relatively safe, like a government bond, into investment-grade credit, even high yield, which you're trying to get a yield, trying to get income from, what you're effectively doing is increasing the equity correlation in your portfolio because they're equity-like instruments.
You're losing that diversification benefit. The why of why people are looking at alternatives for income is very obvious now. It's more around the how in terms of actually putting it in your portfolio which is the challenge.
Kerry makes a really good point there because the other thing that comes with that is at times lack of liquidity.
Some investors don't realise that if we do have some sort of market shock, not all of those assets . Government bonds are really, really liquid. Private credit? Not so liquid.
If you need your money back in a hurry, and a lot of people are trying to get their money back, you're not able to liquidate those investments quickly. So there's that lack of understanding as well.
You've mentioned that low bond yields have created high equity prices. This might seem like a silly question, but shouldn't high equity prices be good for investors?
They are to a degree. The valuations being high is not so good when you think about what that means to your future returns.
The more you pay for something now, the less you're going to get in the future when you sell it. If you simply look at, say, the five-year annualised returns on the equity market, based on what you're paying for it, the higher that starting point is, the lower your expected return is.
And that's why the problem with generating that return from equities in your portfolio becomes challenged in this environment.
It's still positive. Today's market, you'd still be very much allocating towards equities with positive growth and very easy monetary policy. But those returns get compressed as those valuations are higher.
You could argue that valuations on equities can stay high while interest rates are low. And that's true to an extent, but I think the biggest problem is that the valuations are so elevated in some parts of the market, your return expectations need to either come down a lot, or you need to think about how you can take that equity-like characteristic from the equity market and apply it to other assets in your portfolio.
How do investors actually go about accessing these products and what kind of products are available?
As Kerry said, the access has certainly improved and there's a lot of press, as an example, on the Future Fund's asset allocation or the big institutional or industry super funds and their investment in some of the direct assets and so forth.
That's in the press, so you do get investors saying, "Well, how can I get access to those types of assets?"
And the reality is, as Kerry said before, in many cases, you still can't. However, it is improving.
Managers are bringing vehicles, and products and access to strategies that private investors haven't enjoyed access to previously.
It's still, as we said, not quite there yet. But there are very liquid strategies, as we mentioned before, like managed futures, market neutral, global macro.
There's no reason why private or retail investors can't get access to those because they're liquid, they can be packaged up in smaller investment amounts and so forth. It's improving and it's a lot better than it was, and there is a lot of variety.
David, Kerry — thanks for chatting to me today. It's been really interesting to get some insights into the world of alternatives.
Thank you. It's been great to be here.
Thanks, Pat. Appreciate it.
MORE ON Investment Theme
2 contributors mentioned
Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.
No areas of expertise