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Investment Strategy

Private Markets: 4 steps to help you optimize your allocation to alternatives

Individual investors often first get involved in alternative investments through ad hoc, one-off opportunities—or by searching in specific asset class silos (i.e. real assets, private equity, private credit and hedge funds.)  

Even the savviest family offices and pensions often start investing in alternatives on a fairly limited basis: by focusing on a single objective; be it enhanced returns or yield, volatility mitigation or inflation protection.      

But alternative asset classes and strategies have historically proven their worth. We believe traditional markets alone may be unlikely to provide the return, income and diversification that many  investors seek. And the universe of alternatives has expanded offerings so that it now provides investors a robust toolkit.   

Clearly, if you’re going to invest in alternatives, it’s time to build a thoughtful strategy around your allocation. The challenge, of course, is how to  accomplish this feat.1

Here, we provide a quick look at our four-step approach to constructing an alternatives portfolio plus some insights from our experienced specialists to help light the way—so that your investments might more effectively help you reach your goals. 

To us, building an alternatives portfolio starts with defining the outcome(s) you seek so you can properly identify what approach(es) might help you succeed.   

So what do you hope to accomplish? There are generally two main categories investors look to solve for: diversification and return enhancement. 

Given those goals, the choice of investments is sometimes clear, as some alternatives have a distinct, primary function in a portfolio; for example, private equity can be a source of enhanced returns.

However, other categories have multiple functions. Private credit, for instance, can provide inflation protection, yield and enhanced returns. 

Also, while the broad array of investments provides investors great flexibility, it also necessitates an added level of scrutiny, experience and monitoring to uncover all the underlying attributes of each asset class and opportunity.     

The next critical question for those who already are invested in alternatives: How much capital should I put, in total, to work in the private markets? 

The typical range we’ve seen among private bank clients is 15% to 30% of their overall portfolio. That said, some clients with significant resources and an inclination to plan multi-generationally do allocate 50% or more to alternatives; much like some large endowments. 

Carefully consider how much you might allocate to help you achieve your particular goals. As part of that decision process, we can help you evaluate your:   

  • Tolerance for illiquidity and time horizons—The size of your commitment depends in great part on your liquidity needs, as alternatives are by definition less liquid than public market investments; alternatives investors trade liquidity for return potential.

    However, this market has been developing, and opening, to such a degree that it’s time to dispel the notion that you can allocate to alternatives only if you’re willing to lock up your capital for seven or more years.  In fact, alternatives now offer a variety of time horizons.

    Some alternative investments (such as business development companies (BDCs), non-traded REITs and hedge funds) offer monthly and quarterly liquidity2.  This liquidity profile often creates an ability to borrow, should that suit your needs. Indeed, you may be able to as much as get 35% to 50% lending value against such holdings.

  • Existing allocation to alternatives. Before setting a course for new investments, you’d also be wise to look at not only your current investments in alternatives but also at all the assets on your balance sheet. If, for example, you have a private business, you might want to count your investment in it as part of your allocation to alternatives (as your business is a private enterprise and your investment in it is likely to be not only locked-up for but also long-term.) 


We strongly recommend diversifying your alternatives portfolio itself and suggest doing so along key factors such as geographic exposure, manager selection and vintage year—as well as liquidity and strategy.  

The need to diversify geographically is often obvious; across managers, sometimes less so. Yet, in any industry that has higher fees, less liquidity, and less transparency, you want to be careful. Exercise robust due diligence in choosing managers and make sure your manager roster is well-diversified.

As for vintage year diversification: Investors tend to over-over-allocate at the onset, because they want to ramp up. But one of the most important diversification strategies is to take a consistent, measured approach by allocating over multiple vintage years. You want to sustain your exposure and it’s difficult to know which future year is going to be provide the best opportunity.  

For example, think about the outbreak of COVID-19. Imagine the chagrin of investors who’d only invested in vintage year 2017, so that all their capital was put to work by 2020 and they couldn’t take advantage of the COVID-19-generated dislocation but they did have a great deal of exposure to COVID-19’s outcome.  

We believe the way to truly optimize your allocation is to allocate consistently.   Our advice: Consider investing in no less than three vintage years. Many sophisticated investors strive to commit evenly over four to five years and to recycle capital thereafter.

Given the lifecycle of some alternative investments and how critical the timing of vintages is, we suggest that, if you want to get to, say, a 30% allocation to alternatives in your portfolio, you might consider investing only a portion, about 7% or 8% a year. You’d keep that pace until you get to your desired allocation—then refill the funnel as investments realize over time.   

To pick the right partner, you need access to information about the managers running the investment as well as access to investment opportunities themselves.   

The alternatives universe is vast (it now includes more than 18,000 private investment funds and 9,000-plus hedge funds alone).3 Evaluating and monitoring offerings is time consuming and complex, but critical as performance can vary widely. For example: on average, there has been a 21 percentage point difference between performance of top-quartile and bottom-quartile private equity managers and a 13 percentage point difference between top-quartile and bottom-quartile hedge fund managers.4

This chart shows the dispersion in performance between private and public funds based on returns over a 10 year window. Manager dispersion is based on the annual returns for global equities, global bonds, U.S. core real estate and hedge fund returns over a 10 year period ending November 30, 2022. U.S. non-core real estate, global private equity and global venture capital are represented by the 10-year horizon internal rate of return (IRR) ending 2Q 2022. Global equities returns for top quartile managers were 9.6% and bottom quartile managers 7.8% with a median of 8.6%. Global bonds returns for top quartile managers were 2.3% and 1.0% for bottom quartile managers with a median of 2.0%. U.S. core real estate returns for top quartile managers were 12.0% and 10.4% for bottom quartile managers with a median of 11.0%. U.S. non-core real estate returns for top quartile managers were 18.1% and 2.2% for bottom quartile managers with a median of 10.9%. Global private equity returns for top quartile managers were 26.5% and 5.2% for bottom quartile managers with a median of 16.1%. Global venture capital returns for top quartile managers were 34.8% and 0.3% for bottom quartile managers with a median of 15.2%. Hedge funds returns for top quartile managers were 14.5% and 1.2% for bottom quartile managers with a median of 7.2%.

Many clients choose to work with us because of our rigorous scrutiny of managers. Our in-house team conducts on-site visits and we examine, among other factors, the structure, operations, incentives, and individuals on a manager’s team.  

But we also offer access to funds that our global investment strategy team, drawing on our size and scale, creates with select partners. 

Even the most experienced investors can easily be overpowered by the array of alternative classes, strategies, and vehicles now on offer. And all the information in the world is not useful unless it is applied to an individual’s particular circumstances.

We are committed to working with our clients to help them explore all the ways they might achieve their long-term objectives.

For a thoughtful analysis of what steps you might want to take and when, your J.P. Morgan team and our alternative investments specialists are available for consultation.

 

1 For the most experienced and new alts investors alike, barriers can include lack of familiarity, limited information and transparency, liquidity concerns, risk budgets, vehicle access restrictions, fee loads, minimum investment requirements, measuring and modeling complexities, and intra- and inter-asset class correlations and dispersions—for starters.

2 Check particular investments to see what restrictions might apply.

3 Source: SEC.gov, Private Funds Statistics. Data as of Q1 2022. https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2022-q1-accessible.pdf.

4Top- and bottom-quartile private equity managers, for example, have had, on average, a 21% performance differential. In hedge funds, the difference is 13% between top-quartile and bottom-quartile performing managers. Source: Burgiss, NCREIF, Morningstar, PivotalPath, J.P. Morgan Asset Management. Data is as of November 30, 2022. Manager dispersion for hedge funds is based on annual returns over a 10 year period ending 3Q 2022. Global private equity is represented by the 10-year horizon internal rate of return (IRR) ending 2Q 2022. Past performance is no guarantee of future results. It is not possible to invest in an index.

Key Risks

Investing in alternative assets involves higher risks than traditional investments and is suitable only for sophisticated investors. Alternative investments involve greater risks than traditional investments and should not be deemed a complete investment program. They are not tax efficient and an investor should consult with his/her tax advisor prior to investing. Alternative investments have higher fees than traditional investments and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain. The value of the investment may fall as well as rise and investors may get back less than they invested. Diversification and asset allocation does not ensure a profit or protect against loss.

As a reminder, hedge funds (or funds of hedge funds) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.

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Key Risks

Investing in alternative assets involves higher risks than traditional investments and is suitable only for sophisticated investors. Alternative investments involve greater risks than traditional investments and should not be deemed a complete investment program. They are not tax efficient and an investor should consult with his/her tax advisor prior to investing. Alternative investments have higher fees than traditional investments and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain. The value of the investment may fall as well as rise and investors may get back less than they invested. Diversification and asset allocation does not ensure a profit or protect against loss.

As a reminder, hedge funds (or funds of hedge funds) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.

JPMAM Long-Term Capital Market Assumptions: Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations. Please note that all information shown is based on qualitative analysis. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that these asset class and strategy assumptions are passive only – they do not consider the impact of active management. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. The outputs of the assumptions are provided for illustration/discussion purposes only and are subject to significant limitations. “Expected” or “alpha” return estimates are subject to uncertainty and error. For example, changes in the historical data from which it is estimated will result in different implications for asset class returns. Expected returns for each asset class are conditional on an economic scenario; actual returns in the event the scenario comes to pass could be higher or lower, as they have been in the past, so an investor should not expect to achieve returns similar to the outputs shown herein. References to future returns for either asset allocation strategies or asset classes are not promises of actual returns a client portfolio may achieve. Because of the inherent limitations of all models, potential investors should not rely exclusively on the model when making a decision. The model cannot account for the impact that economic, market, and other factors may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual portfolio outcomes, the model outcomes do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact the future returns. The model assumptions are passive only – they do not consider the impact of active management. A manager’s ability to achieve similar outcomes is subject to risk factors over which the manager may have no or limited control. The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit and accounting implications and determine, together with their own financial professional, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield are not a reliable indicator of current and future results. 

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JPMorgan Chase Bank, N.A. and its affiliates (collectively "JPMCB") offer investment products, which may include bank-managed accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC ("JPMS"), a member of FINRA and SIPC. Insurance products are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states. Please read the Legal Disclaimer in conjunction with these pages.

INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

Bank deposit products, such as checking, savings and bank lending and related services are offered by JPMorgan Chase Bank, N.A. Member FDIC. Not a commitment to lend. All extensions of credit are subject to credit approval.