There has never been a better time to add alternatives to your portfolio, according to analysts at JP Morgan Asset Management.
Patrick Thomson, head of international institutional at the firm, says more and more institutional investors are now looking to add alternatives to their portfolios given the difficult market condition seen over the past few years.
“If you go back to one of the more traditional ways a UK pension fund in this country meeting its obligations – which would be a return target of between 6 and 8 per cent –you did that by allocating 60 per cent or at least half of your portfolio to equities and half to fixed income,” he said.
“And you relied on the fact that those two asset classes weren’t perfectly correlated and that equities in the good times would generate a yield that was quite significant over fixed income and then fixed income would protect you when you had volatility in equity markets.
“That was fine and it worked for quite a long time, but as yields have collapsed in fixed income its clearly become more and more difficult. I think what investors have looked at now is they are scrabbling for every possible basis point and there are basis points to be had in the world of asset allocation.”
Over the past year, government bonds and equities have risen somewhat in tandem, with yields falling in the fixed income space thanks to loose monetary policies by central banks and low interest rates.
Performance of indices over 12 months
Source: FE Analytics
As the above graph shows, over the last 12 months global bonds have risen 33.57 per cent, with large parts of the sovereign debt market now bordering or in negative yield territory, while global equities have gained 27.99 per cent.
With both asset classes rising in tandem, investors have had to look elsewhere for diversification.
Thomson said: “This is the idea that no longer can you have just a fixed asset allocation of 60/40 you may have to change that depending on your views and depending on the path of interest rates.
“Insurance companies, pension funds and sovereign wealth funds are exploring other ways of getting those returns in their portfolio and alternatives does seem to be an obvious choice for many of them.”
Declan Canavan, EMEA head of alternative strategies at JP Morgan Asset Management, says there are four main areas investors are turning to.
“We describe alternative as hedge funds, real assets, private credit and private equity. There are other alternatives such as commodities that we don’t really see as being an integral part of institutional investors’ portfolios,” he said.
Real assets, which JP Morgan defines as global real estate and global infrastructure, have proved popular this year among investors looking to find income in unusual areas.
Earlier this year, Seneca’s Peter Elston outlined how he uses specialist real estate vehicles to find yield in an increasingly difficult environment.
He looks at specialist investment trusts that offer something more than equities or bonds, with examples including a more stable income stream than equities, potentially higher yields or perhaps income streams that are more index-linked.
The two examples he gave were Primary Healthcare Properties, which rents land and buildings to doctor’s surgeries, and GCP Student Living, which rents student accommodation to university undergraduates.
Performance of stocks in 2016
Source: FE Analytics
“We consider real asset investing to be on the equity side and on the debt side,” Canavan said.
“They can provide portfolio diversification, they provide income and they provide inflation protection as inflation protection is written into the rental contracts of both infrastructure projects and real estate investing.”
Meanwhile, private equity is being used mainly by those seeking to add return enhancing potential to their portfolios, Canavan says. 
“You’re not really going to get a lot of diversification in your portfolio because this is for those seeking to invest in equity markets but that want to benefit from private or non-public information,” he added.
However, the world of private credit, he says, is a hybrid, offering both enhanced earnings and diversification. “Private credit to our mind is a relatively new asset class,” he said.
It has come into its own over the last 10 years and coinciding first in the US and now in Europe with a lack of traditional sources of credit to market being provided by banks.
“In more recent times banks have been disintermediated from that market, partly through regulation, and the regulators are happy with private credit coming into the market, partly because there have been a whole bunch of esoteric asset classes that have sprung up in the private credit universe.”
Canavan says it has grown from a very small allocation in the institutional space to being a core allocation in investment portfolios
“What I find interesting is most institutional investors view private credit as a fixed income substitute and that chimes with the fact that they see lower or negative yields in government bond portfolios, and the analytical tools that use to analyse private credit are more akin to fixed income than they are to alternative investment.”
However, he continues, the reason they are put into alternative investment portfolios is because of the illiquidity of investing in private credit. “You typically are locking up your money for a longer period.”
The final area is hedge funds, which he says are being used as portfolio diversifiers, despite the misconception that they are predominantly alpha generators.
“A lot of people ask the question: “We associate a hedge fund with a lot of alpha a lot of absolute return and a lot of fees – why do you think of them as diversifiers?’
“Obviously when you’ve got different risk factors contributing to the returns of hedge funds, if you build them into your portfolio you can benefit from diversification. In other words, when one strategy is doing well another is not so good.”