Is Now the Time to Diversify into Alternatives? (July 2022 Insights)
Due to current macroeconomic concerns, many folks are wary of allocating funds to the public market (i.e. stocks and REITs) and investments more broadly. The war in Ukraine, lasting supply chain shortages, rising rates, and persistent inflation, have stoked fears of a possible recession. To this point, purchases of exchange traded funds (ETFs) fell in April to their lowest level since the start of the pandemic in March 2020.
While a reflexive pull back from the equities market is a natural reaction to the current uncertainty, we believe this is an opportune time to diversify into alternative assets, such as real estate.
Opportunities in Alternative Investments
According to Natixis, 78% of institutional investors say there is still a significant delta between private assets and public markets, and 85% of institutional investors anticipate increasing or maintaining their allocations to real estate investments.
Many institutional investors have now pivoted away from the traditional 60/40 portfolio allocation toward a 50/30/20 or even a 40/30/30 ratio, where 20-30% of the portfolio consists of alternative investments such as real estate.
Here are a few reasons why we think it may be smart for individual investors to mimic this strategy in their own portfolios:
1. Stable Source of Recurring Income
Per KKR, higher inflation should lead to increased demand for collateral backed cash flows as inventors move to owning pricing power assets. A great example of this is multifamily real estate, which is partially insulated from this same pressure, as people will always need a place to live.
To put this another way, private real estate does not operate on the same short-term basis as stocks. Landlords can generally count on tenants to pay rent consistently each month. When their lease is up for renewal, it is a common practice to then raise rent for the following year(s), which can and will capture (a portion) of overall market inflation.
2. Potential Hedge Against Inflation
The real estate asset class has historically been more resilient to inflation than public stocks. In fact, KKR notes that real estate returned similar nominal returns in both high inflation and low inflation environments (9.9% versus 11% from 1978-2021). Comparatively, U.S. Equities returned on average 4.2% in nominal terms in inflationary periods, versus 13.9% in nominal terms in non-inflationary periods (from 1928-2021).
3. Greater Portfolio Diversification
Two recently released reports found that investors with higher allocations to alternative investments outperformed those with traditional asset allocations. According to the data,real estate was the only positive performer, with a median return of 5.24% in the first quarter of 2022.
“Endowments benefitted from their above average allocation to real estate and other alternative investments of 60% versus the Master Trust median allocation of 32%,” says Frances Barney, head of global risk solutions at BNY Mellon.
We believe investors looking to enhance a traditional portfolio should consider diversifying into alternative assets. A portfolio that skews heavily into the stock market, for instance, will likely no longer provide the same high returns in current conditions. Even bonds, which investors have historically turned to for stability, may produce diminished returns as the Fed increases interest rates. By rebalancing these ratios and introducing new asset types, investors can potentially improve the resiliency and performance of their overall portfolio.
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