The sheen of alternative assets

THE last 18 months have been an interesting time for the world economy, with post-pandemic recovery, war in Ukraine, inflation surge, interest rate hikes, banking sector crises, changes in demand for commercial real estate, volatility in the financial markets and more. Nevertheless, the pursuit of returns remains at the heart of investing.

Despite the widespread expectation that the US Federal Reserve would cut interest rates by the end of the year, investors and investment managers have been cautious, demanding higher returns before they are willing to place their bets. Notably, in a higher inflation environment, some investors gravitate towards yield over capital gains – presumably due to a need for cash flow.

Against this backdrop, are alternative investments a viable, even compelling, proposition?

Alternative investments

Alternative investments are financial assets that do not fall within the conventional categories of stocks, bonds and cash.

Examples include private equity, venture capital, hedge funds, distressed debt, managed futures, art and antiques, and cryptocurrencies. Subject to eligibility requirements, investors may invest directly in these assets or indirectly through funds.

Alternative investments are generally perceived to come with higher risk, and hence investors expect higher returns. But investors will need to fully understand the features, upside and downside of the asset they are contemplating.

Here are some common features of alternative investments in contrast to conventional assets.

• Alternative investments may be less regulated and availability of information may be limited. Please do your due diligence prior to making an investment
• Returns do not necessarily align with the performance of the economy or the relevant sector. Some products (such as inverse exchange-traded funds or put options) stand to profit in a falling market. Some assets (such as gold) tend to be safe havens in times of crisis. Others (such as commodities) are driven by a completely different set of factors. You would need to know the catalysts driving the assets
• Terms and conditions of alternative investments are often more complex than traditional assets, in order to deliver the additional dimensions of risk and payoffs. Please seek professional advice where appropriate
• They are typically less liquid than traditional assets as the assets are not listed in public markets. There may also be additional restrictions on redemptions. Your investment horizon should match your cash flow needs
• Where there is no public market, valuations of alternative investments may not be transparent, and may involve uncertainties and subjective judgments
• Certain types of alternative investments (such as structured products and derivatives) are subject to significant counterparty risks. Remember Lehman Brothers?

Despite the additional risks, alternative investments have become more popular over the past decade as a tool for excess returns and diversification – important for both wealth preservation and portfolio construction. Public markets are crowded and extremely competitive, and achieving attractive returns is no longer an easy task.

Market analysts believe there are tremendous opportunities in alternative investments. Despite poor market performance in 2022 across almost all asset classes, there is still an increasing allocation of capital into alternative investments.

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A poll by Cerulli Associates showed that asset managers maintained around 15 per cent of their investments in alternatives in the first half of 2022, and intend to increase that proportion over the next two years.

Recent trends

In a speech earlier this year, Lim Cheng Khai of the Monetary Authority of Singapore highlighted not just resilience of the alternative investments industry in Singapore, but also its continued growth and performance, fuelled by diversification away from public markets and investors’ relentless search for alpha.

Singapore’s overall assets under management (AUM) grew 16.4 per cent in 2021 to reach US$4 trillion. Within this, the alternative investment AUM grew at a faster clip of 30 per cent year on year. Hedge funds, private equity and venture capital accounted for two-thirds of total alternative AUM in Singapore, where more than half of the world’s top 50 global alternative managers have set up a presence.

Globally, Preqin has forecast a compound growth rate for alternative investment AUM of 9.3 per cent between 2021 and 2027, higher than the expected growth rate of 4 per cent to 6 per cent for the asset management industry.

We see some key trends. While the once-buoyant venture capital fundraising scene has seen significant dampening, private credit, in particular, is emerging as a growth area for investors and managers who seek attractive yield in a high interest rate and volatile market environment.

In Hong Kong, we have seen a fair number of changes in the asset classes sought by investors over the last few years. On the digital side, there has been a rise in cryptocurrencies, crypto funds and funds investing in private equities of issuers in digital marketing, blockchain, blockchain-as-a-service and metaverse-related industries.

On the physical side, we have also seen hot monies going into art and antiques and funds investing in physical assets such as whiskies, moutai and pu-erh tea.

Private credit, whether secured or distressed, is gaining more traction given the higher rate of returns after the interest rate hikes.

Private equity has enjoyed a decade of strong inflows and higher net asset value/internal rates of return driven by stock markets. But sentiment and valuations have cooled in the last 18 months. Lastly, environmental, social and governance-themed investing is increasingly popular.

Daniel Yong is partner, corporate (Singapore), and Simon Wong is partner, corporate (Hong Kong), Withersworldwide