2019 Outlook: Alternatives

12.10.2018 - Wayne A. Sprague


Unique Characteristics Complement Stocks and Bonds

Alternative investments are not homogeneous, and each category within this broad universe offers a unique relationship with traditional stocks and bonds. As we approach the later stages of the economic cycle in the US and begin to see diverging monetary policy across the globe, we believe it is more important than ever to keep these characteristics in mind.

Hedge funds and liquid alternatives

Investor appetite for hedge funds has diminished over the past several years as equity market performance has been robust. Another factor has been their relatively high fees and a lack of flexibility; most hedge funds are structured as limited partnerships, so they have lock-up periods and less liquidity than traditional investments.

But it’s important to keep in mind that market conditions can change quickly. Does anybody remember the so-called lost decade? From the beginning of 2000 to the end of 2009, the S&P 500 provided an average annual return of -0.95%. As we approach an economic cycle that is in the later stages, we believe hedged investments will begin to add diversification benefits to portfolios due to their unique characteristics. Specifically, they offer returns that are expected to exceed bonds, and volatility that is anticipated to be well below stocks.

Furthermore, we have seen the emergence of the liquid alternatives category, which has provided our clients with low realized beta of 0.31 against equities over the past three years. This low correlation to equities offered a meaningful degree of downside protection during periods of market volatility. We continue to support moderate allocations to hedging strategies in the range of 5% to 10% for most client portfolios.

Private equity

Investor appetite for risk has steadily increased over the past 10 years, fueling demand for private equity investments. The challenge for investors in 2019 will be finding private equity managers who take a disciplined approach to entrypoint valuations and don’t overpay. The cycle for private equity is much longer than liquid asset classes, so we are being extremely selective in seeking true value-add strategies.

That said, we are maintaining our constructive view on the venture capital category, as opportunities have expanded beyond information technology and software to now include industrials, the financial services landscape and the energy complex. Disruptive business models are popping up everywhere and new generations of consumers are demanding products and services that suit their preferences and support more efficient lifestyles. We are not underestimating this changing dynamic, and venture investments often represent the first dollars that flow into these emerging businesses.

Commodities are typically a good diversifier for portfolios during periods of high inflation, albeit with low or no income yield and unfriendly tax implications.

Real estate

We are also taking a selective approach to real estate in 2019. Valuations have recovered from the financial crisis, particularly in metropolitan areas, and funding costs are on the rise. Within the REIT category, we favor real estate companies tied to the fulfillment of technology and telecommunications growth. Additionally, we are exploring newly-created Opportunity Zone incentives that were written into the 2017 tax changes. Many clients have unrealized gains in their portfolios, and the ability to defer taxes and invest in impact-oriented strategies is an intriguing concept that has some merit.

This analysis is provided for illustration and discussion purposes only and does not guarantee future results. Please speak to your Fiduciary Trust contact if you have questions or would like more information. This communication is intended solely to provide general information. The information and opinions stated are as of December 1, 2018, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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