Investment Strategy

How do you build an alternatives portfolio that supports your goals?

Apr 18, 2022
Our answers to some of clients' most frequently asked questions.

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FEMALE VOICE: This audiocast has been prepared exclusively for accredited and qualified investors only, as defined by local laws and regulations. Please read other important information, which can be found at the end of the article.

Kate Donovan Morgan: Hello. My name is Kate Donovan Morgan, Head of Alternative Investments for the U.S. Central & Western Regions.

Today we’re answering three of our most frequently asked questions on how to build an alternative investment portfolio that supports your goals.

A top question I’ve been getting from clients is where to look for potential enhanced returns given our public market outlook being lower than previous years.

An allocation to private markets via private equity, private credit and real assets—could offer the opportunity for higher returns in excess of their respective public market equivalents.    

With private equity, clients trade liquidity for the possibility of enhanced returns and to get access to a larger opportunity set. In the U.S. alone, there are approximately 10x more private companies than there are public ones.

Private credit can also be a return enhancer.  Private lenders can often dictate favorable loan terms in privately negotiated financing solutions with their borrowers. Whether it be through direct lending strategies across the capital structure or more special situations oriented credit, the private debt markets continue to scale as a meaningful part of the market. It’s also worth noting that some private loans are floating-rate, which can be another positive for investors in a rising rate environment.

Another common question from clients is how to mitigate risk from rising rates, inflation and geo-political tensions. You could de-risk your portfolio altogether – but that could also come with lower returns. We find many investors looking to alternative strategies to help diversify their portfolio risk.

Alternatives – like real assets – have different risk drivers than stocks and bonds. Right now, when the traditional risk dampener like fixed income, may no longer smooth volatility – allocating to real assets could make sense.

The real assets category includes both traditional real estate that has tended to perform well when rates are rising as well as infrastructure strategies that may also have the benefit of inflation-adjusted cash flows.

Accessing real assets through private (or nontraded) structures can also help insulate you from volatility in the public markets.

Lastly, many clients are asking how to mitigate shrinking yield from a traditional fixed income portfolio. Many of the Alternatives I’ve already mentioned could also help answer this question.

Allocating to direct lending strategies, high quality core infrastructure, and open ended real estate managers could all be tools in increasing overall portfolio yield – and in some cases with monthly or quarterly liquidity.

You can read the full article for more in-depth insights on how to build an alternatives portfolio that supports your objectives.

As always, we are committed to working with our clients to explore all the ways they might achieve their goals. Please contact your J.P. Morgan team to learn more and let us know how we can be of help!

FEMALE VOICE: This audiocast is intended for informational purposes only.  Views may not be suitable for all investors and are not intended as personal investment advice or a solicitation or recommendation.  Outlooks and past performance are never guarantees of future results. 

Alternative and private investments involve a high degree of risk, has lack of information, limited liquidity, may use significant leverage, and could lose up to the full amount of their invested capital. These investments are intended for eligible long-term investors who have the financial ability and willingness to accept the risks associated with making speculative and primarily illiquid investments. The value of the investment may fall as well as rise and investors may get back less than they invested. Past performance and outlooks are not a guarantee of future results.  More complete information is available, including a product profile, which discusses risks, benefits, liquidity and other matters of interest.

Please read other important information, which can be found at the end of the article.

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You’re a very experienced investor. Yet with such a wide array of alternative strategies and vehicles available to you, you may still wonder which makes the most sense given your goals, circumstances, risk tolerance and views on the markets. Alternatives fall into many categories, and have many uses. They may benefit portfolios whether the objective is risk reduction, return enhancement, higher income or some combination.

Here, our specialist answer some common investor questions to help you consider what might be right for you.

 

Q: With the J.P. Morgan outlook for public market returns lower than in the past, what are the options for potentially accessing higher returns?

A: Consider an allocation to private markets—private equity (PE), private credit and private real assets. In exchange for illiquidity and different risks, you’d have the potential for enhanced returns compared to public indices—as well as access to markets and geographies not otherwise as easily accessed via public markets.  If you’re already investing in alternative assets, consider increasing these allocations over time if your liquidity budget allows.

Capturing the higher returns you’ve counted on to meet your goals can be hard. Our 2022 Long-Term Capital Market Assumptions (LTCMAs) forecast (over 10 to 15 years) 2.8% annual returns for U.S. investment grade bonds, 3.9% for high yield bonds and 4.3% for mid-cap equities. But in private markets, the direct lending forecast, for example, is 6.9%; for private equity (PE), it is 8.1.1

That enhanced opportunity arises, in part, from private markets’ broader opportunity set: The U.S. is home to fewer than 8,000 public companies, yet more than one million private companies, and companies are generally staying private longer. Top managers work with firms most likely to grow, and they bring operating expertise, in an environment that’s not managing to quarterly earnings calls but long-term business growth. Private investment funds also tend to be rather insulated from mark-to-market volatility compared to exchange-traded firms, supporting their companies through difficult environments.

Real asset and private credit markets can also offer diversification. Venture capital, growth equity and buyout funds tend to be oriented towards long-term growth and innovation megatrends but have historically outperformed their public market equivalents. Real estate and infrastructure investments may be portfolio essentials in an inflationary environment given that their returns have historically outpaced inflation. 

Within private credit, direct lending across the capital structure has provided attractive yields relative to public markets given the pullback of banks from lending since the financial crisis, and this may help provide some diversification, tempering volatility. Distressed credit funds may be an avenue to higher growth as managers can invest in hard-to-access dislocated assets.

 

Q: The yield from my traditional fixed income portfolio is shrinking. How can I raise my portfolio’s yield and at the same time reduce the risk that inflation, and likely Federal Reserve rate hikes, erode the value of my investment?

A: We have seen many clients pursuing alternative yield strategies by using alternative credit strategies and/or leaning in to core and core plus real assets. 

Credit alternatives: Direct lending are strategies that may appeal to investors who want traditional credit but with a higher yield because of their less-liquid nature and managers’ ability to privately negotiate credit documents with issuers.  Strategies investing in senior (first repaid) floating-rate debt can benefit from a rising rate environment.

High quality infrastructure, real estate and core real assets: An allocation to these relatively stable alternative asset classes, funded from your core fixed income allocation, can increase portfolio income. Many such strategies now come in more liquid, accessible forms than they once did.

Stable infrastructure projects such as financing wind installations, water utilities or other essential community services offer visibility into steady, long-term cash flows, made possible by government concessions, long-term contractual revenues with investment-grade counterparties and inflation-linked pricing. 

 

Q: I’m concerned about geopolitical uncertainty, a changing market regime, inflation and rising rates. I’m willing to take some risks, for the opportunity to achieve the returns to meet my goals. How can I diversify risk in my portfolio?2

A: Consider funding an allocation to hedge funds and/or real assets.

We understand. Some of the traditional approach to lowering risk—for example, by shifting some public equities allocation to fixed income assets—may no longer dampen volatility while also introducing duration risk.  

Hedge funds as diversifiers? You may not realize that hedge funds can help diversify portfolios and be tailored to your risk tolerance and investment objectives. A diversified hedge fund strategy that can invest in a wide range of styles and securities, has the potential for uncorrelated return streams relative to other risk assets, and improve risk-adjusted returns.

To be sure, hedge fund strategies could carry duration risk and if you fund a hedge fund allocation with fixed income proceeds, you could give up consistent income generation. But some hedge fund portfolios do hold fixed income instruments.

Our large platform of hedge funds allows for building a customized exposure if, for example, you have a strong interest in a sector, or a specific perspective (like a bearish market view). Some hedge fund types are designed for low correlation with global equity and credit markets, such as so-called “relative value” and “macro” hedge funds. Or you may want exposure to the markets’ direction, suggesting an allocation to “long/short equity” and “event-driven” hedge fund strategies.  Performance varies widely, making manager selection critical—on average top quartile hedge fund managers outdo the bottom quartile by 13 percentage points, on average.3

Real assets as diversifiers? Allocating to real assets, a less-liquid portfolio diversifier, can also help reduce volatility over time because real assets have different return drivers from stocks and bonds. Real estate, for example, historically tends to do well in rising rate environments. Infrastructure investments may have inflation-adjusted cash flows from essential services. Accessing real assets through private (or nontraded) structures can help insulate you from public market volatility.

 

Q: I’m concerned about giving up too much of the liquidity that’s available in public markets. Can I still invest in alternatives in a way that would provide monthly or quarterly liquidity and lending value?

A: To be sure, private market investors often give up liquidity. You’d also move into a different risk profile. Starting to invest in private markets is a long journey and requires diversifying across strategies, funds and vintages.

It may be best to build exposure gradually, following a customized roadmap. At the same time, some alternative investments (such as some hedge funds, business development companies and non-traded REITs) do offer monthly and quarterly liquidity.4 It may be possible to borrow against some open-ended and hedge fund strategies, depending on their liquidity profile and subject to lending advisor approval.

We can help

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 to optimize your alts portfolio for your needs, talk to your J.P. Morgan team.

 

 

1 J.P. Morgan Asset Management, Long-Term Capital Market Assumptions 2022. As of Dec. 2021.
2 Diversification and asset allocation does not ensure a profit or protect against loss.
3 Lipper, NCREIF, Cambridge Associates, HFRI, J.P. Morgan Asset Management, based on latest available data as of February 28, 2022. 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 4Q 2021. U.S. non-core real estate, global private equity and U.S. venture capital are represented by the 10-year horizon internal rate of return (IRR) ending 3Q 2021.
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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.

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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. Annuities 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

Equal Housing Lender Icon 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.