Page 44 - Investment Advisor June 2022

ALTERNATIVE INVESTMENTS

By Josh Vail

At This Critical Point, Choose Your Own

Portfolio Construction Adventure

There are two paths to ride out rising inflation, high valuations and an

inverting yield curve.

f you grew up in the 1980s or allocation strategy and duration-sensi-
1990s, you probably remember tive bonds losing nearly 10% in the first
Ithe Choose Your Own Adventure quarter of 2022, advisors may be seek-
series, where, as the reader, you would ing alternatives.
step into the shoes of the main char- Within this choice, there are num-
acter. Choose one path and you’d ber of options that haven’t been as
find yourself surrounded by carniv- attractive in recent years as they are
orous dinosaurs. Choose the other today. Advisors may choose to look at
and you might be trapped aboard an the hedged strategy space for the first
alien spaceship. time in years. Strategies like market
In January, the annual inflation rate neutral or long-short equity are also
for the United States was the highest options, aiming to isolate factors that
it has been since 1982. Because many are not correlated to inflation or rising
of us in the industry were kids devour- interest rates.
ing Choose Your Own Adventure books cap rate expansion, resulting in total Turning to private markets once again,
during the last such environment, it’s returns that exceed inflation. private credit is a space that many inves-
a significant milestone: For the first Private equity is also a good choice tors find comfortable. While investments
time, we’ll have to manage assets in an as it tends to outperform when pub- can range in credit quality, it’s possible to
environment that includes record infla- lic markets falter. According to iCapi- find senior secured investments. Often,
tion, high valuations and an inverting tal, six months around an initial rate these have underlying notes that are
yield curve. hike, stock returns are on average flat variable in nature and carry inherit pro-
What does all this mean? That we’re to slightly negative, and 12 months after tection against interest rate increases.
at a critical decision point in our “port- the first hike only see modest gains of Advisors must understand the nuances
folio construction” adventure. For advi- 3%-6%. Meanwhile, when public mar- of these investments, such as underlying
sors looking to utilize alternatives, there kets returned between -5% and 5%, all leverage and where an investment stands
are two paths: private equity funds outperformed the in the capital stack. Being over-leveraged
public index by 6.5% to 8.2%! or allocated too heavily to subordinate
CHOICE #1: INCORPORATE Many investors may choose to out- debt could lead to exposure with unde-
ALTERNATIVES THAT ARE pace inflation as well as returns of sired idiosyncratic risk characteristics.
CONSIDERED RETURN ENHANCERS. traditional asset classes by incorporat- Unlike in the Choose Your Own
Those who choose this path want to ing return-enhancing alternatives into Adventure books, advisors and clients
outpace inflation by incorporating an their portfolios. If current valuations also can choose to blend several strate-
option like private equity or real assets are a concern, perhaps choice #2 is gies to take an objective/risk replace-
into their portfolios. more attractive… ment approach, especially if they’re
Real estate investment trusts (REITs) underweighted to alternatives. As we
as an asset class has been a strong per- CHOICE #2: HUNKER DOWN AND head into this new adventure of weaker
former in 2021 and 2022 through April MANAGE VOLATILITY. bonds and equities, more diversification
and rents can escalate quickly with Since the beginning of the last bull mar- could be your best path to choose.
multifamily investments. Thanks to its ket a decade ago, hedge strategies have
macro tail winds, infrastructure could struggled to achieve market returns. But Josh Vail, CAIA, is managing director of Adobe Stock
improve revenue numbers faster than with a 60/40 equity/fixed income asset Hamilton Lane.

42 INVESTMENT ADVISOR JUNE 2022 | ThinkAdvisor.com