The Importance of Alternatives to Investors

Five Things You Should Know

1. Equity Markets – finished mixed this week with U.S. stocks (S&P 500) up 0.01% and international stocks (EAFE) falling 0.71%   
2. Fixed Income Markets – moved slightly lower this week with investment-grade bonds (AGG) down –0.19% and high yield bonds (JNK) falling –0.21% 
3. Eurozone Sticky Inflation – Investors got another reminder of the perils of betting on a rapid decline in inflation on Wednesday, as the UK’s slowdown on price gains wasn’t quite as fast as economists predicted. The small headline miss, 2.3% rather than the predicted 2.1%, plus a stubbornly high services reading, sparked a market reaction. That was felt most keenly in the UK, where investors have all but abandoned hopes of a June rate cut from the BOE. 
4. China Warning – Equities in Europe were also hurt by China’s signal that it is prepared to impose tariffs on imported vehicles with large engines. The China Chamber of Commerce to the EU said it was informed about the potential move by “insiders”, and the levies would affect European and US carmakers and could have a “significant” impact on relations with the EU.
5. Key Insight – [VIDEO & ARTICLE] – This week we address not only why “alternatives” have become such a topic of conversation, but also outline some surprising facts around the economy and markets as relates to alts as we explore the opportunity and important considerations for investors.

INSIGHTS for INVESTORS

Intro

Chances are you have read about the “rise of alternative investing” in recent months. There is certainly a proliferation of various projects and investments to try to capture the public’s increased attention and appetite in the space.

Here at TEN we’ve discussed in these commentaries, and utilized various alternatives, for years now … largely to reduce exposure to investment grade fixed income during the low yield years leading up to 2022 sell-off.

While what one defines as an alternative can vary, for our purposes we generally view them as any investments that should act differently than the usual stocks and bonds that comprise most investor’s holdings.

Why Consider Alternatives?

The first big reason is enhanced options. One of the key tenets of our investment philosophy is seeking flexibility and optionality in the solutions we can bring to bear for clients. When it comes to improving one’s options considering the types of private markets often accessed through alternatives because obvious when you consider the facts below.

In his recent piece entitled, Public Markets Are a Small Part of the Overall Economy, Torsten Slok highlighted some facts that demonstrate the opportunity that lies within private markets. See accompanying graphic.

Source: Apollo, 5/19/24

As he noted, “Most of the time in financial markets is spent on discussing Apple, Tesla, and Coca-Cola, but these firms and the rest of the S&P 500 companies only make up a very small part of the US economy.”

The second big reason is the ability to improve one’s risk-adjusted returns. As the graphic below from JPMorgan’s Guide to Alternatives points out, the addition of alternatives to almost any mix of stocks and bonds over the last 35 years has not only improved returns but reduced volatility.

Costs & Considerations

As we’ve discussed around other topics in recent commentaries there is always “price of admission” to making money as an investor. Most commonly people think about risk/volatility, but another “cost” that can open up other potential benefits deals with liquidity.

To be clear, there are a lot of great types of alternatives that are relatively liquid, but for many types of alternatives dealing in private markets (equity, credit or real estate) one usually has to give up access to their funds for a number of years due to the nature of either the asset class or approach to it. In return, many of these investments can give investors outsized returns.

Considerations for clients considering such investments are whether they qualify, can they afford to give up access to their funds, and if the answer is yes to both of those then how while they properly structure their portfolio to accommodate these holdings.

Summary

Whether more liquid alts or more private alts are the right fit for you, the key point is that some form of them likely belongs in your portfolio.

Which ones, and how to use them, are exactly what we’d be happy to talk to you more about anytime.

Please check out the wonderful article below highlighting our Hightower partner and Head of Alternatives, Robert Picard below.

Have a wonderful weekend,

Tim and the team at TEN Capital

HNW Investors Must Raise Their Private Markets Ambitions – Hightower Advisors

By Tom Burroughes, Family Wealth Report 3/29/2024

There’s a relentless drumbeat of noise about the need for HNW individuals to ramp up holdings of private market and alternative assets to diversify and capture returns, but they’re still lagging behind large institutions.

And with so-called “evergreen,” aka perpetual structures becoming a more prominent feature of the private markets space, there’s also a new way of accessing these relatively illiquid areas.

Robert Picard, managing director and head of alternative investments, Hightower Advisors, said the shift toward private market investment needs to happen. His firm has plenty of weight in the area, with $142 billion of assets under management, as of the end of 2023.

The average university endowment fund, or billionaire, has approximately more than half of their assets allocated to private markets. With individual investors, on the other hand, the average exposure is less than 5 per cent. The traditional 60/40 split is still a dominant approach, he told Family Wealth Report in a recent call.

“We now know that portfolios with large allocations to alternative assets tend to deliver better risk-adjusted returns,” Picard said. “Clients have to be rewarded with higher risk-adjusted returns in exchange for [taking] accepting that illiquidity.”

The structure of American capitalism, in terms of how firms are owned, has shifted in the past four decades. There are fewer firms listed on US exchanges. In 1976, the US had 4,943 firms listed on exchanges. By 2016, it had only 3,627 firms. From 1976 to 2016, the US population increased from 219 million to 324 million, so the US went from 23 listed firms per million inhabitants to 11. (Source: National Bureau of Economic Research, 2018.) Instead, privately-held firms have become more significant. However, for years, investors have had to put up at least $1 million to enter private equity – and sometimes far more. 

With the rise of fintech platforms such as iCapital and CAIS in the US, and Moonfare in Europe, there is a gradual shift toward improving access to private markets. Regulators such as the US Securities and Exchange Commission are mulling ways to assist the process – in a controlled way. The SEC, for instance, has adjusted the Accredited Investor rules to widen access to some extent.

In Europe, this news service was told at a Luxembourg funds conference about how regulators and fund providers are looking at how to make alternative funds more open to retail/affluent clients. In the past, regulators have not deemed illiquid assets as suitable for retail investors. 

Guidance
Education and guidance of clients is important, Hightower’s Picard said. If one takes a snapshot of all the US companies that generate more than $100 million in revenues, approximately 87 per cent of them are still privately held firms, Picard said. “We can provide private investment solutions to complement traditional public equities and fixed-income portfolios,” he said. 

The minimum AUM that clients have to put into private markets used to be in the region of $25 million, but that’s changing. “Evergreen” structures are “leveling the playing field,” he said. “That’s what we are witnessing right now.”

Evergreen structures are open-ended funds with no termination date. They can recycle capital from realized returns and are not bound by the same time constraints as other private market investment vehicles. In the case of US investment group Blackstone, for example, a perpetual fund it has created allows 2 percent to a maximum of 5 percent of the fund’s value to be liquidated per quarter. The firm said this sort of structure is well suited to the mass-affluent segment, with minimum investment ticket sizes of $25,000 – way below the much larger minimums that private equity, credit and other non-public funds often ask for.

Picard is enthusiastic about such developments. 

“The democratization and miniaturization of private markets also benefit our capital markets,” he continued. “These portfolio allocations to private markets require investors to take a longer-term market view. If people go from five, 10 to 20 percent allocations via evergreen vehicles then you are going to see a wave of more than $1 trillion of new assets moving into these markets over the coming years,” Picard said.

There are other forces driving change, such as in the private credit fund space, he said.

The decline in the number of US community banks, and consolidation among such regional/local lenders, means that private credit funds are stepping in and filling the lending gap. This is mainly due to shifts across the traditional lending ecosystem away from community banks due to rising rates, he said.

“The C-Suite leadership teams currently in place across corporate America have just experienced and survived a global pandemic, supply chain disruptions, rising interest rates, labor force shortages and inflation. These professionals represent some of the most sophisticated operators we’ve seen across multiple generations of corporate leaders. We see private credit funds taking advantage of this environment to generate better risk-adjusted returns than traditional public fixed income,” he said.

“We are in a normal cycle now and there will be a reasonable amount of rising defaults. This is quite healthy,” he said. “All of this is going to benefit investors [across multiple asset classes]: they become the bank,” he said.

DATA, JUST THE DATA

U.S. Jobless Claims – fell by 8,000 to 215,000 on the week ending May 18th. This landed well below market expectations of 220,000.  

U.S. MBA Mortgage Applications – jumped by 1.9% from the previous week for the period ending May 17th. This added to the 0.5% increase from the earlier week. This marked the third consecutive week of growth in mortgage demand. 

U.S. Durable Goods Orders – rose by 0.7% MoM in April of 2024. This followed a downwardly revised 0.8% increase in March and defied market expectations of a 0.8% decrease. 

U.K. Retail Sales – declined 2.3% MoM in April of 2024, following a downwardly revised -0.2% fall in March and forecasts of a -0.4% drop. It is the biggest decrease in retail sales in four months, with sales volumes declining across most sectors. 

Eurozone Composite PMI – rose to 52.3 in May of 2024. This was the highest in a year, compared to 51.7 in April and beat initial forecasts of 52. The reading showed the economic recovery in the Eurozone gained momentum, amid faster increases in business activity.