The current economic climate can be characterised by rising interest rates, high inflation, and bank failures. This has created heightened uncertainty and increased volatility, particularly in public markets.
As a result, many investors are turning to private and alternative investments as a way to mitigate risk and achieve more stable long-term returns. Private investments offer potential advantages in volatile times, including lower correlation to traditional public markets and greater portfolio diversification.
Snowball Effect's Director of Private Capital, Bill O'Boyle, looks at alternative investment options to consider during uncertain times.
When referring to 'traditional markets' or 'public markets', we are thinking about public equity markets such as the NASDAQ, ASX and NZX that are the home for listed bonds and equities.
When referring to 'private markets' and 'alternative investments', we are thinking about investments into venture capital, private equity, private credit, and actively managed funds that focus on alternative strategies that are less correlated to traditional markets. Often these actively managed alternative strategies will have a much wider mandate to utilise commodities, futures and other derivatives to achieve their investment objectives. The use of options can also allow alternative strategies to limit downside risk. Examples of actively managed alternative funds include private credit funds, agriculture funds, and climate focused funds.
While both public and private markets are impacted by inflation and higher interest rates, these factors typically create more volatility in public markets than private markets. For instance, high inflation reduces the real rate of return on fixed-income assets (bonds) which creates the potential for a negative yield on a bond.
Similarly, rising interest rates increase the cost of capital, reducing future cash flows for businesses, which reduces company valuations. The impact is typically more pronounced and immediate for businesses that are publicly traded, as they are priced dynamically.
Private markets and alternative investments are often less correlated with public markets, meaning they can provide a hedge against market volatility. This is particularly crucial when public markets are volatile and inflation erodes the purchasing power of cash.
Moreover, private markets offer investment opportunities that are not readily available in public markets, thereby providing additional diversification opportunities. Private equity, for example, is a longer-term investment that helps insulate investors from short-term market volatility.
Additionally, private market investments are often in the early stages of development and not yet public, offering greater potential for future growth and higher returns over the long term. However, these investments are typically illiquid and harder to exit, making it important to consider the impact of rebalancing a portfolio or liquidating investments for other uses.
Alternative investments account for approximately 12% of the USD $153 trillion global asset market (Source: The Portfolio for the Future by CAIA Association).
Ultra-high net worth investors may allocate up to 50% of their portfolios to alternative investments in order to preserve capital and achieve solid returns throughout market cycles. More moderate net worth investors typically allocate a single-digit percentage into alternative investments, whilst many investors allocate nothing at all to alternative investments and are at the mercy of the swings in market cycles.
The increasing trend of allocations to private markets and alternative investments is however clear, with the alternatives market growing 15% annually from 2015 - 2021, and expected to continue to grow at approximately 11% annually for the next five years, according to Prequin.
Volatility is an inevitable trait of market cycles, and in uncertain times diversification is crucial. Private markets and alternative investments provide complimentary options to achieve greater diversification and help mitigate market risks.
Considering how alternative investment options can allow you to construct a well-balanced portfolio that optimises for your goals is important, and this becomes even more apparent when public markets are volatile as they are at the moment.
With a longer-term investment horizon and less focus on live pricing, private market investments can help to stay focused on long-term objectives, reducing emotional decision-making based on short-term volatility.
The good news is that investment platforms like Snowball Effect are increasingly providing simple access to alternative investments that have historically only been utilised by sophisticated investors. In the near future, we will be expanding the range of alternative investment options we offer, providing simple access via our platform.
This information is general in nature and is not intended to be financial advice. You should consult a professional financial adviser before making any financial decisions or taking any action based on the opinions expressed above.