December 3, 2021
Outlook for 2022: Alternative assets
(In)dispensable elements
The dearth of decent investment options in the fixed-income sector and ever-decreasing equity return expectations are causing alternative assets to continually gain importance. But not all alternatives are equally attractive.
Alternative assets that promise a steady absolute return enjoyed a further surge in demand in 2021. Investors particularly turned their sights more to the private equity theme. Possibilities to invest in non-publicly traded companies had long been the exclusive privilege of large institutional investors (and required minimum investment sums of several million US dollars), but in recent years we have seen an accelerated trend in efforts to make private markets accessible also to smaller institutional and even retail investors and to “democratize” this asset category. The origin of the interest in (and allure of) private markets is as clear as day: real yields on fixed-income assets are negative (with few exceptions), and expected long-term returns on stocks are also extremely meager after inflation is deducted.
Although it won’t be possible to make a final 2021 performance comparison with other asset classes until the middle of Q1 2020 due to the low frequency of valuing private-market assets, one nonetheless can already assert that private equity once again lived up to its return promises this year. In fact, the private equity sector experienced an unprecedented boom that included records set with regard to the number of transactions, deal sizes, and a performance that is likely to have even edged out that of the very robust public stock markets. Signs of a certain degree of overheating are now unmistakable, though. A critical view should be taken, for instance, of the fact that prominent (and lesser known) private equity houses not only have plans to roll out ever larger funds, but also to launch them at ever shorter intervals. This means that there is more and more “dry powder” lying around that wants to get invested – at ever higher valuation multiples. Nevertheless, the outlook for private equity remains favorable, particularly relative to public markets because in addition to the valuation lever, private equity managers have a variety of other adjusting screws that they can tweak to boost the value of their portfolio companies. Moreover, in the past, private equity has consistently provided better inflation protection than the public equity market. Well-diversified private equity investments look destined to continue generating double-digit annual returns in the years ahead. Private equity managers themselves at least continue to foresee profitability in that range for their investments. After all, their business doesn’t really pay off for them unless the return exceeds certain target hurdle rates. However, one idiosyncrasy of this asset category that warrants attention is the fact that there are usually very wide performance differences between the good private equity funds and the bad ones. Picking the right managers (and gaining access to them) is therefore crucial. It takes know-how and resources to separate the wheat from the chaff, so whoever is interested in private markets should work together with experts.
The universe of hedge funds is similarly as diverse and complex as private markets are. This is reflected in hedge funds’ performance this year. Trend-following CTAs have profited from the big moves in commodity prices, and sector and stock rotations (and the performance dispersion between individual stocks) on the equity market have benefited long/short funds. Macro funds, in contrast, had a tough time navigating the challenging macroeconomic environment in the second year of the pandemic. Choosing the right selection of hedge fund strategies and managers is likely to be an essential key to investment success again next year. Whoever succeeds in picking the winners can benefit from the low correlation with other asset classes and can improve the risk/return characteristics of his or her portfolio.
A mixed boutique
Selectiveness and choosing the right picks were (and remain) trump cards
Performance of alternative assets (as of 30 November 2021)
Sources: Bloomberg, Kaiser Partner Privatbank
Gold in the past has likewise worked well to improve a portfolio’s risk profile. However, this classic alternative asset posted a patchy performance track record for 2021. The price of gold spent three-quarters of the year on a volatile rollercoaster ride and thus for long stretches disappointed those investors who were counting on the yellow metal to protect them against inflation. It took an extreme inflation overshoot and new all-time lows in real interest rates to give the precious metal a significant uplift since early October, which finally enabled gold to also climb out of its downtrend channel that had been in place for over a year. So, from a technical analysis perspective, the nearer-term prospects for gold have brightened. Over the longer term, though, there is a question of whether the yellow metal’s acceptance among large and small investors as a diversifying element and a protector against inflation will erode further in favor of cryptocurrencies, a trend that has evidently gained momentum in this year now drawing to a close. Gold, in the meantime, remains an integral component of our strategic asset allocation for now even though we are not wildly enthusiastic about its prospects for the new year and are maintaining a neutral tactical position in the metal.
In contrast to gold, investments in real estate delivered positive returns this year. The performance spectrum ranged from solid (Swiss real estate funds: +5%) to spectacular (US REITs: +30%). The heterogeneity of the real estate asset class and the diverse array of investment vehicles (region/sector/category, public/private) render it difficult to make generalizations about the prospects for 2022. Nevertheless, “concrete gold” should continue on the whole to deliver positive value contributions next year. Although much of the real estate sector appears very overheated like a lot of other assets, in many cases the high prices are being driven not by cheap money alone, but also by accordingly tight supply and demand conditions, which the pandemic and the trend toward remote work from home have tended to tighten even further. However, a trigger capable of bursting the purported bubbles is missing at present at least in the real estate markets in the USA and much of Europe, where the interest-rate level will stay low in the quarters ahead and the severe dearth of better investment alternatives will persist. So real estate, like gold, continues to belong in any investment portfolio, in our view.
Let’s close with a few words about commodities, which many investors continue to view as a standalone alternative asset category. When we removed crude oil, industrial metals, agricultural commodities and the like from our investment universe at the start of this year as part of our revision of our strategic asset allocation, we weren’t guided solely by peering through “sustainability-colored glasses.” The fact that passive investments in commodities often detracted from overall portfolio performance in the past due to erratic price movements and negative roll yields was also a very important consideration. Severe supply and delivery bottlenecks amid robust demand fueled a high double-digit percent performance in the commodities complex this year. The macroeconomic climate looks set to keep a cyclical tailwind behind commodities in early 2022. Investors, however, can profit from this even without holding a dedicated permanent spot reserved for commodities in their portfolios. We think it’s much better to invest indirectly via systematic hedge fund strategies that only invest in commodities in times when strong, profitable trends prevail.
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