Global turmoil has been driving investors into unknown territories. These experts break down the upsides and dangers of an exciting yet unproven alternatives market.

The alternative investments industry has grown substantially over the past decade, a rise which is predicted to continue as investors grow wary that the 10-year bull market may be coming to an end. Combined with a steady decline in the number of listed stocks, industry insiders have predicted that continuing difficulties of finding alpha in public markets will result in increasing allocations to alternatives in place of traditional 60/40 portfolios.

But, as well as the need for alpha, industry figures also expect that technology is likely to drive more investors towards alternatives. By aiding the development of more sophisticated alternative products, technology can improve the understanding of the role that alternatives can play in portfolios as well as increase market transparency.

‘I don’t think any institutional investors would argue with the premise that traditional equities are not necessarily going to give you the kinds of return over the next five or 10 years that they’ve given you in recent decades,’ says William Dinning, chief investment officer at Waverton Investment Management. ‘That means that people will be not just seeking ways to mitigate volatility and to mitigate capital loss, but they’ll also be looking at other ways they can generate total return.’

Financial data analysts Preqin have estimated the alternative assets industry to be worth a colossal $14 trillion (£11.5 trillion) by 2023. But at the same time, many suspect that the accuracy of this valuation will ultimately depend heavily on how alternatives perform during the next market downturn.

‘Seeing how these strategies perform through a severe test will really dictate how the space is shaped, subsequent to that,’ says Jessica Milsom, senior associate at Stonehage Fleming.

Jessica Milsom, Senior Associate at Stonehage Fleming

The need to be aware of overall liquidity profiles when structuring portfolios around liquid alternatives is also of vital importance, says Kelli Byrnes, a consultant within BlackRock’s portfolio analysis and solutions group. ‘Funds need to be responsible, and if there’s a mismatch in the liquidity they’re offering in the underlying, that has to be noted and investors need to be aware of it. Illiquidity is not a bad thing – it’s how you can potentially get a premium – but it needs to be balanced from a portfolio construction point of view,’ she says.

‘When we look at the liquid alternatives, people are certainly going to be much more discerning than they ever have been before, and this will be a real test,’ says Alex Orr, director within BlackRock’s alternatives specialists team. ‘Clients are going to start to look away from some of the high beta strategies that they might have had allocations to before, and really look for those uncorrelated diversifying strategies.’

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At the same time, Orr suggests that there is likely to be significant growth in private markets such as infrastructure and private credit, both in the wealth management sector, and also further down the ladder as clients become more comfortable and accustomed to investing in these sectors. One of the key mechanisms driving this growth is the European Long-Term Investment fund (Eltif). Insiders feel this could have a similar impact on private markets as the Ucits did to the hedge fund industry when it was introduced a decade ago.

‘Institutional investors have been allocating to this area for a long time, but what we’ve also seen is more and more wealth clients moving into this space,’ Orr explains. ‘Clearly, that’s at the upper end, the ultra-high-net-worth individuals, but also there are now structures to allow high-net-worth and more retail investors to invest in this space as well. The Eltif is making it much more accessible to a wider audience.’

‘When we look at the liquid alternatives, people are certainly going to be much more discerning than they ever have been before, and this will be a real test,’
Alex Orr, director within BlackRock’s alternatives specialists team

However, as the alternative space continues to rapidly evolve, the risks will also increase, especially in sectors which remain relatively unproven, such as private debt. Some managers have pointed out that one of the dangers of the rise of the Ucits framework is that it has driven more inexperienced allocators into alternatives, who remain relatively naive to some of the risks associated with these strategies.

‘If you get uninformed investor demand that just goes for the pockets that have done the best, then you’re going to reach capacities, breach liquidities and you could end up with a scenario where there’s some really good alternatives out there, but they end up getting crippled because of overly increased flow,’ says Shane Balkham, chief investment officer at Beaufort Investment Management.

However, with new technologies and the increasingly volatile and unpredictable political environment pushing greater numbers of investors towards new strategies, alternatives allocations appear almost certain to increase in years to come.

‘In my opinion, this is undoubtedly going to continue to be a growth area, which means people are going to have to get to understand it a bit better and they’re going to be allocating more money to it,’ Dinning says. ‘How they do that, whether it’s with a dedicated external manager or by themselves, that depends, but I think the amount of capital going into this is just going to increase.’