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The role of alternatives in a changing world

12 June 2024

Investors need to consider looking beyond public markets to help build diversified and therefore resilient portfolios.

By Aaron Hussein,

JP Morgan Asset Management

The traditional investment portfolio, epitomised by the 60:40 split between stocks and bonds, has long been considered a safe and reliable strategy for balancing growth and risk. Either times were good and stock prices went up, or the economy faced troubles and investors flocked to the safety of bonds, pushing up their prices.

However, as 2022 showed, stocks and bonds tend to move together in periods of high inflation, significantly reducing bonds’ ability to diversify your portfolio when faced with an inflation shock. And it’s likely we will see more inflation shocks over the next 10 to 15 years, driven by three key factors. 

First, the era of globalisation that defined the past several decades appears to be fading. Rising trade barriers, tariffs, and protectionist policies are increasingly hindering the free flow of goods and services. At the same time, rhetoric around immigration has grown more heated and restrictive in many countries.

Second, labour shortages will become more pronounced as demographic shifts and changing workforce dynamics take hold. An aging population in many developed countries, coupled with a decline in birth rates, is reducing the labour pool.

Moreover, the lingering effects of the Covid-19 pandemic have accelerated shifts in employment preferences, further exacerbating labour scarcity.

Third, climate change is increasingly disrupting supply chains, reducing agricultural yields, and increasing the costs of raw materials.

This means investors will need to consider looking beyond public markets to help build diversified and therefore resilient portfolios. Here’s where alternatives come in.

Alternative investments are a broad category encompassing private equity and private credit, as well as hedge funds and ‘real assets’. Real assets which include real estate, infrastructure, transport, and timber, have historically demonstrated low correlations with traditional asset classes, offering investors broader diversification opportunities.

Real estate and infrastructure tend to be leased to occupiers or operators on long-term leases, with clauses that allow rental increases at certain time periods, either by a fixed amount, or in line with a price level.

These built-in escalation clauses allow cash flows to grow over time. This last quality is especially attractive in a world of more frequent bouts of unexpected inflation – inflation that would otherwise eat into investment returns.


The equity market is changing

In addition to the challenges posed by a changing macroeconomic environment, the investment landscape is also changing, with companies choosing to stay private for longer.

In 1999, the median age of a company at IPO was four years; by 2020 this had risen to 12 years. As a result, the number of publicly listed companies has been steadily declining.

Between 1997 and 2022, the number of US listed companies fell by more than 30%; in the UK it fell by almost 60%. If you only focus on traditional public markets, public equity now provides exposure to a dwindling proportion of the total equity universe. 

The flipside to a dwindling public equity universe is a rapidly expanding private equity universe. In fact, private equity now comprises 85% of the total investable equity universe and provides investors with access to some of the fastest-growing companies that are simply not available through public markets.

By investing in private markets, investors can participate in the value creation process and potentially capture outsized returns.


Gaining access

Alternatives have traditionally been the preserve of institutional and high-net-worth investors alone, but regulation is playing a key role in changing that. The introduction of frameworks such as the European Long-Term Investment Fund (ELTIF) and the UK Long-Term Asset Fund (LTAF) aim to provide retail investors with access to long-term, illiquid assets while ensuring appropriate investor protections.

As these regulations evolve, they may further democratise access to alternative investments and expand the opportunities available to investors.

Of course, investors must approach these assets with a clear understanding of their unique risks and considerations, such as illiquidity and the importance of manager selection.

But given the combination of broader diversification, protection against inflation, and access to a wider opportunity set, these investments are no longer just alternative. They’re essential.

Aaron Hussein is a global markets strategist at JP Morgan Asset Management. The views expressed above should not be taken as investment advice.

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