Miami, FL - 2/20/2023
Will 2023 Represent A Rising New Paradigm For Alternatives?
An uncertain future continues to highlight various alternative strategies that outperformed public markets in 2022 and may usher in a golden age for alts.
As many investors worry about the possibility of a recession in 2023, they’re also receiving a number of mixed signals from various news and media outlets. Consumer confidence, spending, and employment, as well as the housing market, remain relatively stable despite inflation and rising interest rates. Even business confidence stayed positive for most of 2022 in a year defined by record-high consumer prices, supply chain shocks and political conflict in Europe.
If the economy just doesn’t make sense anymore to investors, one reason might be because there’s a certain lack of coherence – no unifying theme that could help explain what might happen next. The outlook for 2023 remains inconclusive, but some alternative asset classes will seek opportunities for strong performance in this environment, as they did in 2022.
Is Global Uncertainty the New Normal?
In 2022, spiking inflation dominated headlines. In 2023, recession risk could surface as the dominant economic theme, after two-quarters of contraction in mid-2022 and a significant slowdown in employment. While history doesn’t necessarily repeat itself, the types of managers and strategies positioned to thrive in the past have generally been those prepared to capitalize on global uncertainty: global macro, equity market neutral, as well as multi-strategy on the hedge fund side; and private credit, LBO, and some venture on the private markets side.
Volatility across asset classes – stemming from uncertainty – could allow some strategies to thrive in the current environment, as others take a back seat and struggle. Many investors, economists, and TV analysts are predicting a slowdown as the Fed continues to tighten monetary policy – though it’s worth keeping in mind recession pessimism could become a self-fulfilling prophecy. COVID is likely to still play a factor in overall markets, as China retires its zero-COVID policy and cases continue to spike, bringing back supply-chain concerns.
Check For Scope
Second, check for scope. The best alts platforms should offer access to a wide range of funds that can provide diversification across business, strategy and vintage risk. Lack of range may indicate shelf space is being limited to quid pro quo arrangements.
When checking for quality, advisors can look for funds from institutional managers with proven track records in navigating multiple market cycles. These firms often do not enter into pay-to-play schemes and have a well-honed reputation in risk management, computing power, disaster recovery plans and much more.
While institutional managers denote quality, emerging managers are newcomers to the private fund space who don’t have the same safeguards and risk management infrastructure in place that institutional funds have developed over time.
Emerging managers, particularly those with a track record of one to three years, will allow platforms to partake in the management fee or performance fee – oftentimes in exchange for distribution and shelf space. Needless to say, this impacts platform neutrality, and raises the chances of certain products being promoted over others.
Ultimately, pay-for-play relationships are just one example of a potential conflict that can exist within alts platforms. Advisors should be aware that there are other inherent risks and conflicts that can exist and may take many forms – due diligence is key in choosing the appropriate alts platform for your advisory business.
Private Markets Grew in 2022
In 2022, U.S. dollar-denominated risk assets experienced a year-over-year selloff in public asset markets: The S&P 500, Dow Jones Industrial Average, U.S. Treasuries, Barclays AGG, and cryptocurrencies saw double digit drops. Energy, agricultural, and industrial commodities prices also witnessed declines. Many of the same strategies that performed well in 2022 may be likely to continue outperforming the public markets, which may usher in a golden age of alternatives – as the 60/40 portfolio won’t be as reliable as it was pre-pandemic, and investors continue to look high and low for alpha.
Last year, on the private market side, while overall private equity performance softened, private credit witnessed enormous growth, owing to a number of factors. When rates rose and risk appetite dropped, the primary market for syndicated and leveraged loans nearly evaporated. We witnessed a transition from banks being the primary source of funding, to the direct lender ecosystem, a subset of private credit. As credit spreads and rates remain high we could expect to see outperformance in private credit, as most private debt are floating rate assets.
Global macro, a hedge fund strategy that allows managers to nimbly play across marketplaces, countries and asset classes, capitalizes on dislocations in the market. Nearly every Hedge Fund Research Index (HFRI) outperformed the S&P and AGG in 2022. We saw strong returns in strategies that traditionally capitalize on high volatility and market uncertainty, with the HFRI Total Macro Index returning +9% over the last year, and the HFRI Equity Market Neutral Index seeing returns of nearly 2%. Investing in private funds is considered highly risky and carry the risk of a partial or complete loss of capital. Nevertheless, alts are gaining a reputation among investors seeking to diversify their portfolios, reduce volatility, and generate income, with hedge funds, in particular, being sought after by investors seeking these opportunities.
On The Cusp of a Golden Age
Advisors are taking notice, adding to the possibility we are on the cusp of a new paradigm or a golden age of alternatives. According to a white paper from Cerulli Associates issued in July 2022, reducing exposure to public markets was reported by advisors as a top reason for using alternative investment products.
Investing in assets with a low positive correlation, or even negative correlation, has generally been a leading strategy among institutional and high-net-worth investors for decades. Amid unprecedented global events, however, strategies such as the 60/40 portfolio, although slightly rebounding in 2023, proved to be insufficient for many investors seeking alpha, inflation protection, and diversification. Understanding the potential new golden age of alternatives, then, means recognizing its increased relevance among an expanding universe of investment solutions available for advisors, who are shedding the old way of doing things in a brave new world.
In a time of uncertainty, alternatives might make sense as a component of stabilizing an overall portfolio by seeking to manage volatility –preparing investors long-term, while zeroing in on specific goals that go beyond cookie-cutter solutions. Relatively illiquid alternatives, while having their own unique set of risks and complexities, also can help advisors guide investors to long-run goals, while seeking to insulate their clients from what could be a very different environment over the next decade.
Steven Brod is CEO and CIO of Crystal Capital Partners, winner of a 2022 Wealth Exemplar Award in the category of Alternative Investments Platform of the Year.
Steven Brod is CEO of Crystal Capital Partners, an alternative investments platform for financial advisors.