They are not for everyone. But the alternatives can produce the return that fixed income securities cannot.
Investors who think alternatives are synonymous with hedge funds, risk and volatility would do better to think again, especially if income generation is a primary goal. The truth, mostly known to high net worth individuals and their financial advisers, is that the alternatives can fit well into a fixed income allocation. In fact, one of the best reasons to turn to “alts” in the past year was income.
Private credit – the most popular alternative asset class for this purpose – private real estate and infrastructure funds generated returns of between 5% and 8% in 2021, often with less risk and volatility than their listed counterparts. “It depends on the strategy, but each of these three asset classes is capable of producing income in this range,” said Cliff Corso, chief investment officer of Advisors Asset Management. âIt’s the liquidity you give up and the illiquidity you get paid more for. “
|Fund / Ticker *||Holdings||Distribution rate||Liquidity|
|BlackRock / CREDX credit strategies||Private and public debt||6.4%||Quarterly|
|Blackstone Private Credit / N / A||Private credit||8.1||Quarterly|
|Blackstone / BXSL secured loans||Private credit||6.7||Daily|
|KKR Real Estate Select Trust / KRSTX||Private and public real estate||5.4||Quarterly|
|Flexible municipal income Pimco / PMFLX||Public and private municipalities||4.0 **||Quarterly|
* Some funds are only available through certain financial advisers and are subject to other restrictions. ** Taxable equivalent distribution rate
Source: company reports
In practice, this means that many hedge funds that hold illiquid private debt only allow quarterly withdrawals, and even these can be limited if many investors try to cash out at the same time. Interval funds, a structure commonly used for illiquid asset classes, allow 5% of assets to be withdrawn each quarter, and if requests exceed that amount, investors receive their share on a pro rata basis. This shields existing investors from the negative effect of an exit rush, which could force fund managers to raise funds much faster than they can offload private holdings.
Losing some liquidity is a reasonable price to pay for the attractive returns and other perks offered by these asset classes, including welcome diversification away from traditional stocks (with high valuations) and bonds (with paltry returns). and a worrying interest rate risk), says Michael Harris. , director of the family office practice at Verdence Capital Advisors. One major plus point: Private debt is usually at variable rates, so yields should rise again if prevailing interest rates rise as expected. Rising rates usually lead to lower prices for bonds issued at fixed rates.
âIn today’s traditional bond market, even a high yield is not a high yield,â says Harris. Junk bonds yield between 4 and 5%. âIt’s high risk, but you’re not getting a lot of return on your investment,â he adds. âThis is why we had clients in private credit in 2021, and in 2022 we are actively seeking more private credit managers who can strengthen portfolio returns. “
Private credit tends to earn more than publicly traded debt, mainly because lenders bypass public markets and the bank lending process, says Brad Marshall, co-head of Blackstone Credit’s Performing Credit Platform and CEO of Blackstone Credit. Blackstone Private Credit Fund, a private business development company, or BDC. This fund has attracted $ 12.6 billion in equity and has returned 11% since its launch at the start of the year. “By issuing a direct loan to the business, lenders end up keeping more of the return and more return is passed on to investors,” he explains.
In its investigation of the capital market assumptions held by pension fund managers, Horizon Actuarial Services found that they expect asset classes such as real estate, private debt and infrastructure have a total return outlook that is similar to or better than that of large cap stocks. over the next 10 years.
These investments benefit from the economic recovery and their status as “strong hedges against inflation”, explains Corso.
John Bowman, executive vice president of industry association alts CAIA, says huge global infrastructure deficit makes infrastructure investments, sometimes in partnership with municipalities, “the best-kept secret of the alternative buffet “.
That’s not to say they aren’t without risk and complexity. While income-oriented alternatives have performed well over the past 18 months, “in a risk-free environment, net asset values ââcan decline over a short period of time,” says Michael Sheldon, chief investment officer at RDM Financial Group. âWe often limit a client’s alt position to around 5% of total assets. He also tends to favor offerings from some of the bigger companies with bigger brands, including
Starwood Real Estate Trust
Richard Daskin, head of RSD Advisors, recommends getting into these funds after a market downturn. âThe time to accept an illiquid investment is when there isn’t a lot of liquidity,â he says. âThat way you get rent for your cash. “
Funds can have very high minimums and are often only available to high net worth individuals who qualify as âaccreditedâ or âqualifiedâ investors through a financial advisor. Investors interested in these asset classes can start by asking their financial advisors what relationships they have in place. Some use leverage and may include additional tax complexity. Some private funds may be included on a 1099 tax form, but others may require the extra work of completing a K-1. âInvestors need to do their homework and understand the details of what they are buying,â says Sheldon.
Listed mutual funds, closed-end funds, or BDCs that invest in private credit, real estate, and infrastructure are available, but they may not be pure games, or they may be traded on stock exchanges, which adds volatility.
For example, the
Blackstone secured loans
(BXSL) is a publicly traded BDC that holds securities similar to those of Blackstone Private Credit. âSome investors like BXSL for its daily liquidity, but it is subject to stock market volatilityâ and may trade at a higher or lower net asset value than its book value, says Joan Solotar, Global Head of Private Wealth Management Solutions from Blackstone. “Others prefer the private option, where you don’t have to worry about a premium or a discount.”
Still, investors who don’t have access to higher yielding private funds might find publicly traded options in certain categories of income-producing assets that are worth considering, says Harris of Verdence: âThey add more. diversification to portfolios at a time when stocks are at all time highs and you’re not getting much return from fixed income. There really is no better time to have diversified strategies in your portfolio.
Write to Amey Stone at [email protected]