Five things investors should be thinking about right now

Dania Zinurova

Wilson Asset Management

Inflation is increasing rapidly around the world, with Australian consumer price inflation hitting its highest level in more than 20 years at 5.1%. In response, central banks are almost universally tightening monetary policy, with the Reserve Bank of Australia recently raising interest rates by 0.50%, the largest single increase since 1994, for two consecutive months. Disposable incomes are being squeezed by the dual challenges of increasing interest rates and the rising costs of food, fuel, power and other essential items. As the battle against inflation intensifies, the threat of recession once again looms over the global economy.

Given this backdrop, it is no wonder markets have been highly volatile in 2022, with mainstream financial markets in negative territory for the year. Equity markets have experienced steep falls with the S&P/ASX 200 Index falling 11.8% in the first half of the 2022 calendar year. Bond markets have also declined in response to higher inflation and the prospect of higher interest rates to combat it.

In this highly volatile and unpredictable environment, there are five factors that investors should be thinking about right now.

1. Diversification

The current turmoil in public markets has demonstrated that conventional portfolio allocations that balance between public equities and bonds are no longer sufficient, with both asset classes demonstrating correlation through their steep declines recently. This necessitates the inclusion of a broader range of asset classes within an investment portfolio to ensure sufficient diversification moving forward, which take the form of ‘alternative’ assets.

Investing in alternative assets provides investors with strong diversification benefits as the investment returns of the various asset classes are driven by different factors to public equities and bonds, hence ensuring they have low or negative correlation to those more traditional asset classes. Alternative asset classes include private equity, infrastructure, real estate, private debt and natural resources, such as agriculture and water rights. Including these investments ensures that an investment portfolio can still thrive at different stages in the economic cycle. An example of this is how GDP-linked infrastructure, such as airports and toll roads, can perform well in the expansion phase of a cycle while social or renewable energy infrastructure can thrive in a downturn given its returns are driven by long-term contractual revenues often linked to CPI and are less correlated to GPD.

2. Quality

As a result of the long-term investment horizons that often characterise alternative investments (for example, typically 3-10 years), there is an immense focus on investing in quality assets. Investing with a focus on quality and fundamentals ensures that assets can be resilient in economic downturns, withstanding risks that may emerge such as increased debt pressure from rising interest rates and potentially lower consumption as a result of declining consumer sentiment. As investors in alternative assets, we conduct thorough due diligence on every investment we consider to ensure we have full conviction before we commit capital, including on the quality of management, the robustness of the investment case, potential competitors and the wider opportunity set. This focus on quality becomes even more invaluable in a challenging and unpredictable economic environment.

3. Downside Protection

An additional benefit of investing in alternative assets is that they are considerably less volatile than their listed counterparts due to their unlisted nature. While this doesn’t mean they are immune to what is occurring in the broader economy, in the short-term, they are not exposed to the radical day-to-day swings in sentiment that drive much of the volatility in equity and bond markets. Instead, as mentioned above, alternative asset investing maintains a focus on quality, with valuations primarily reflecting long-term fundamentals as opposed to short-term irrational exuberance or panic, thereby reducing the volatility they experience.

4. Inflation Resilience

Certain alternative asset investment strategies also provide the additional benefit of hedging against inflation, either due to a natural or contracted cause. An example of this can be seen in infrastructure, which represents investments in assets that provide essential services or facilities to our society and economy, such as airports, hospitals and wind or solar farms. Infrastructure assets are often characterised by long-term contracts with highly creditworthy counterparties (which are often governments), those business are often monopolies or have high barriers to entry. The revenues derived from these contracts are often CPI-linked, thus increasing along with inflation and providing an investment portfolio with a valuable hedge.

5. Look for Structural Growth

As a result of the long-term investment horizon that often characterises investments in alternative assets, investments must be premised upon long-term structural trends that will continue through changing economic conditions. Megatrends such as digitalisation, climate change, increasing demand for food and global aging populations represent immense shifts that will transform global economies and societies. Investing on the basis of these megatrends ensures that even amidst current high volatility, investors can maintain conviction about the dependable growth that can be delivered by these megatrends.

With the threat of recession looming, the need to include alternatives in an investment portfolio is greater than ever. Institutional investors, such as super funds, have long realised this, with many of the top performing funds rapidly increasing their allocations to alternatives, especially amidst the challenges in the current environment.

Investing in alternative assets has traditionally been limited to these institutional investors, as well as high net worth individuals, due to the large minimum ticket sizes required for a single investment (often $10 million). WAM Alternative Assets (ASX: WMA) however, seeks to democratise investing in alternative assets for retail investors through its listed investment company (LIC) structure, which provides investors with access to a diversified portfolio of alternative assets while also providing them liquidity and a steady stream of dividends.

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WAM Alternative Assets provides retail investors with exposure to a portfolio of real assets, private equity and real estate. The company aims to expand into new asset classes such as private debt and infrastructure.

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Dania Zinurova
Portfolio Manager
Wilson Asset Management

Dania has held senior investment roles in Australia, the US, Europe and the UK throughout her 24-year career. Dania joined Wilson Asset Management in 2020. Previously, Dania was Head of Real Assets Australia and held other investment roles at WTW...

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