When you want to tackle such a complex task as giving an outlook for a very heterogeneous investment proposition as alternatives are, some points have to be established beforehand. Initially, it is very important to define what is meant – at least to the author of this article – by the currently very inflationary used term (liquid) alternative assets.
To my mind it is not an asset class but a way to describe strategies that try to harvest one or multiple risk premia that are not part of the classical asset allocation framework thinking i.e. equities, bonds etc., so being complementary as well as not necessarily new. Beside all the as “liquid” marketed strategies i.e. UCITS, one could also include strategies that combine a classic risk premium like credit risk with another – otherwise difficult to capture – premium e.g. liquidity. That and because the market participants see them as a big part of that universe we can also include private equity and debt here despite the classic risk premium is dominating the “alternative” one.
We also have to differentiate the outlook in terms of what your intention in investing in these strategies is, return or portfolio diversification? This is important as mostly the first part is looked for but to my mind the biggest advantage of most of these strategies lie in the second argument, nevertheless often accompanied with some pickup.
With regard to the above mentioned, I think it would go too far for this article to look at every part of the alternative asset market in detail. However, there are some characterizing macro developments for all kind of these strategies that are important for the current year and beyond, be it private equity, private debt, multi risk/style premia, hedgefunds, cat bonds and so on. On the one hand the combined inflows of new capital were and still are unprecedented (see chart). Especially when you look at the former two as well as in the liquid space e.g. all the style factor products, the magnitude becomes clear. On the other hand the question who will be the marginal buyer occurs when you read about all the done and still ongoing big institutional investments and recruiting efforts for due diligence and investment positions. That just simply means to me that potential future returns have already been significantly reduced, not only in historic but also in absolute terms.
Positively viewed the opportunity set got bigger due to the creativity as well as implementation and sourcing power of the financial sector. Combined with the changing financing and regulatory environment that set the stage for an overall growth and depth of the market as a whole as well as becoming available for more market participants.
Why invest in alternative assets?
On the more cautious side one could also argue that the current overwhelming interest in all kind of these products and strategies is just a function out of desperate need for any kind of positive or targeted yield or just out of “FOMO” (fear of missing out). Especially on the non-equity part of the market that behavior of investors is very pronounced. The low interest rate environment makes formerly “exotic” and illiquid parts of the market suddenly interesting and in institutional meetings perceived bond substitution strategies are topic No.1. So if you follow that argument it is just a matter of time when the other side of the “too much money chasing the same assets”-argument is coming due.
Concluding to my humble opinion the following things are crucial when approaching and investing in the asset class as well as giving a forecast how returns and risk will develop in the future. Regarding potential returns, first and foremost expectations have to be realistically managed and secondly appropriate due diligence resources have to be applied avoiding permanent losses of your invested capital. But even if you properly do your homework, be humble in terms of your return expectations and avoid all the behavioral traps, I think the big and easy money has already been made and you have to be aware of the fact that you are probably very late to the party. I fear disappointments are more probable than positive surprises, at least in the midterm.
When it comes to the diversification effect, understanding what drives your potential returns and risks is crucial. Are you just paying up for a new marketing idea, fund structure or liquidity risk or is there really a different risk premium harvested in addition to what you already own. But if you find really independent risk premia e.g. natural catastrophe insurance premiums the future for that part of the outlook looks very promising not just for 2020.