banks kept rates near zero for many years before beginning to raise rates recently , with plans to raise rates dramatically to combat inflation underway .
Takeaway . While fixed-income yields have been rising , they are still below historical levels , and investors are seeking alternative sources of yield .
Potential solutions : Private credit , real estate and alternative credit funds .
Correlations . Due to the interconnectivity of the global markets , correlations have risen over the last couple of decades . To compound the problem , in periods of shocks like the pandemic , most major asset classes moved in lockstep with one another .
Takeaway . Investors need to identify asset classes and investments that exhibit low-negative correlation with traditional investments .
Potential solutions : Global macro , managed futures and natural resources .
Inflation . After the economy was flooded with easy money to offset the effects of Covid-19 , inflation began spiking in 2021 , reaching levels not seen in decades . Many pundits have suggested the Fed is behind the curve and waited too long to begin combating inflation . In July , the inflation rate was reported at 9.1 %, its highest level since the early 1980s .
Takeaway . Investors need to identify investments that can help in fighting the corrosive impact of inflation .
Potential solutions : Real estate , private credit , infrastructure and natural resources .
Volatility . The events above have led to increasing volatility , both in the number and magnitude of market shocks . We are constantly reminded of the fragility and interconnectivity of the markets and need to prepare for future shocks .
Takeaway . Investors need to identify investments to help buffer increased bouts of volatility .
Potential solutions : Natural resources , macro and multi-strategy hedge funds .
Putting Theory Into Practice To effectively deal with the challenging environment , advisors should utilize alternative investments , as sources of growth and income , as tools to dampen volatility , and as a means of hedging the impact of inflation . These valuable and versatile tools are now available to a broader group of investors , at lower minimums , with lower fees , and more flexible features , as I described in articles in the January-February Investments & Wealth Monitor and the May issue of Financial Advisor .
As the chart below illustrates , institutional investors have allocated to an entire spectrum of alternatives in a diversified fashion . Public and private pension funds , sovereign wealth funds , and endowments and foundations have all committed significant capital to private equity , private debt , hedge funds , real estate , and infrastructure .
The largest institutions often allocate most of their capital to a diverse set of alternatives . For example , the target alternative allocation for Yale ’ s endowment is more than 78 % as of June 30 , 2020 , with specific target allocations to venture capital , leveraged buyouts , real estate , natural resources , and absolute return strategies . 1 The target allocation to U . S . equities is a mere 2 %. We ’ re not suggesting that advisors follow the Yale allocation with their HNW investors ; we ’ re using the example to illustrate how one of the most successful endowments allocates capital . Let ’ s consider the following case study . Jim and Mary Smith are both 60 years old and have three children — Jamie 25 , Jackie 21 and Joanie 18 . Jim is a successful attorney and Mary is a schoolteacher . They both plan to retire at 65 years old . The Smiths have been able to save $ 5 million ($ 3.5 million in their personal accounts and $ 1.5 million in their IRAs ). Their current income is approximately $ 650,000 per year ( Jim ’ s salary is $ 500,000 , Mary ’ s salary is $ 75,000 , and they have $ 75,000 in portfolio income ). They have no debt , no immediate cash flow needs , and they have experience investing in alternative investments . The Smiths are focused on capital appreciation over the next 10 years and have a healthy appetite for risk .
Based on the Smiths ’ wealth and income , their experience with alternative investments , and their long time horizon , they are good candidates for alter- figUre 1 :
Allocation Across Investment Tools
■ private equity ■ private debt ■ Hedge funds ■ real estate ■ infrastructure
20 %
15 %
10 %
5 %
0 % |
private pensions |
public pensions |
Sovereign Wealth funds |
endowments |
foundations |
Source : prequin and caia association , 2021 .
September 2022 | financial adviSor magazine | 39