Investment Strategy
Alternative Investments in 2024: Our advice on what to watch
By almost any definition, 2023 proved to be the year of the “everything” rally.
The U.S. stock market soared, with the S&P 500 returning more than 26% for the year, and bonds made a remarkable comeback. The catalyst for this unexpected shift? Lower inflation, a surprisingly resilient U.S. economy and the prospect of easier monetary policy and declining interest rates in the months to come.
Looking ahead, we believe private markets have the potential to deliver competitive returns versus public markets, as well as diversification benefits. And, given the current interest rate headwinds, we think private credit may be a strategy to explore. Investors should consider the risks associated with private markets, however, and be prepared to gauge their potential impact on their portfolio.
Here, we look across the landscape of alternatives strategies and ideas for 2024: private equity, private credit, real estate, infrastructure and secondary strategies.
Private equity: In a world of opportunity, the potential to access sources of growth
Over multi-year time horizons, private equity has a historical track record of delivering returns and outperformance versus public markets—irrespective of economic booms and busts1.
The post-pandemic global interest rate reset, however, has proven challenging. Higher interest rates have meant a higher cost of leverage for private equity managers—creating a headwind to achieving target returns. Investors need to be mindful, now, of the balance between access to secular growth opportunities—such as those arising from artificial intelligence (AI), health care, security and fintech—and the leverage that may be embedded in them.
We see a sweet spot for private equity managers that use less leverage and focus their strategies on high quality companies that demonstrate durable growth. These managers often don’t need to rely heavily on rate-sensitive financing to take advantage of powerful thematic growth drivers.
Private credit: Stepping in, when capital is scarce, to provide financing
After the regional bank crisis of 2023, many financial institutions stepped back from the lending business, cutting their balance sheet exposure and tightening their lending standards. As a result, businesses in need of new financing are facing greater difficulty in securing capital: Bank lending has waned and public market debt issuance is still low, even though it is beginning to come back to life.
For private credit managers, however, the prevailing market environment offers increasing opportunities to step in and provide access to capital. Today’s elevated base rates have translated into higher yields for investors (see below), and the industry’s use of more protective loan covenants may provide greater investment security relative to other types of fixed income
Current direct lending yields continue to exceed those of other types of fixed income
Yield (%) by fixed income investment category
Source: Bloomberg Finance, Cliffwater, J.P. Morgan Private Bank. Data as of June 30, 2023
With interest rates higher than they have been in a decade, investment opportunities are appearing in certain rate-sensitive pockets of the economy. In the commercial real estate (CRE) lending market, for example, higher rates increase carrying costs for property owners, many of whom are now facing near-term debt maturities2. With regional banks now looking to offload CRE loans on their balance sheets, private credit managers are gaining access to new, potentially lucrative refinancing opportunities.
Similarly, companies with floating rate debt are also feeling the squeeze of higher costs, and signs of stress are beginning to emerge in the leveraged loan market (see below). Experienced fund managers may be well positioned this year to benefit from any resulting dislocations.
Interest coverage ratios for B-rated issuers in the U.S. loan market have deteriorated significantly
Source: Moody’s Investors Service, data as of December 2023.
Real estate: Valuations soften, but overall fundamentals remain relatively healthy
In recent months, despite numerous headlines about office vacancies and foreclosures, real estate fundamentals have remained relatively healthy across most property sectors—with the exception of office properties. Although property values have softened across most sectors, leverage levels remain in check and we see few signs of oversupply3.
Looking ahead this year, we do expect some pockets of distress to appear, largely driven by near-term debt maturities. But we are also beginning to see opportunities to leg into investments in property sectors with secular tailwinds—such as single-family homes, life science offices and data centers—at lower prices4. These lower prices could mean better entry points in high conviction property sectors and geographies.
Infrastructure: Structural macroeconomic transitions help drive potential returns
Of all private market segments, infrastructure has been one of the fastest growing thanks to its ability to help deliver diversification benefits and mitigate inflation, and its potential for consistent returns.
Over the past decade, the industry has evolved dramatically. No longer are infrastructure investments focused solely on traditional assets, such as utilities and energy. Now, infrastructure investments stand at the heart of structural macroeconomic shifts, such as the move away from fossil fuels toward more climate-friendly energy sources.
We see digital infrastructure, in particular, as a sector primed for growth as mobile data usage rises exponentially, markets rush to integrate “5G” or fifth generation mobile wireless networks, and companies seek to enable resource-intensive AI5. Providers of data centers, fiber optic cables and cell towers can all benefit from these secular tailwinds.
Infrastructure returns have proven resilient through inflations cycles
Core infrastructure offers potential inflation mitigation and steady income
Source: MSCI, J.P. Morgan Asset Management; data as of June 2023.
Secondaries: Benefiting from an industry in need of liquidity
Institutional investors are often required to maintain portfolio asset allocations within specific ranges, and—with private investment distributions at their lowest levels since 2009—many investors are experiencing negative net cash flows for the first time since the global financial crisis (see chart below).
As a consequence, some of those investors may be forced to sell a portion of their existing private investment commitments in “secondary” markets, which enable them to find a buyer for those existing fund obligations—and either rebalance their portfolios or cover their liabilities. Individual investors with multi-year time horizons might want to consider investing in these opportunities. Although price discounts have tightened over the past several months, we still believe that value can be found.
For the first time since the global financial crisis, cash flow from limited partners has turned negative
Limited partner cash flow and net asset value (U.S. and Europe)
Source: Cambridge Associates, Lexington Capital Partners, Preqin. “Net cash flow to limited partners” defined as distributions less contributions; 2023 is a pro-forma estimate for 2023 based on Cambridge Associates’ data as of June 30, 2023.
We can help
The need to overcome today’s investment challenges presents a compelling reason to explore alternatives—and we think investors should explore them in 2024.
As always—and especially in alternatives—due diligence and fund selectivity are essential, as performance can vary widely across active managers6. Many investors choose to partner with us to narrow the alternative investment universe because of our rigorous scrutiny of managers. Our in-house team performs extensive analysis and conducts on-site visits, examining the structure, operations, incentives and staffing on a manager’s team.
As one of the largest alternatives platforms, we set out to continually bring a carefully curated set of high conviction opportunities to help you realize your goals.
If you’re interested in learning more about our alternative investment platform, the latest opportunities, and how they may fit in your financial plan, speak with your J.P. Morgan team, or let us reach out to you by filling out the form below.
1Burgiss (now part of MSCI); data as of June 30, 2023. Data from buyout strategies and vintage year defined by first cash flow. Includes mature buyout funds with vintage years between 1997 and 2017. “Direct alpha” measures the relative outperformance (or underperformance) of a private equity fund over a benchmark index as an annualized rate of return. Positive direct alpha indicates outperformance compared to the index return, and negative direct alpha indicates underperformance. The MSCI ACWI Index may not be representative of global public markets as a whole, but is used herein solely because it is a well-known and widely recognized index that covers approximately 85% of the global investable equity opportunity set.
2Emily Yue, “CRE Mortgage Maturities & Debt Outstanding: $2.8 Trillion Coming Due by 2028,” Trepp, December 21, 2023.
3Source: Green Street Advisors, MSCI, National Council of Real Estate Investment Fiduciaries , National Association of Real Estate Investment Trusts, J.P Morgan Asset Management; data as of September 30, 2023.
4Source: Green Street Advisors, MSCI, National Council of Real Estate Investment Fiduciaries , National Association of Real Estate Investment Trusts, J.P Morgan Asset Management; data as of September 30, 2023.
5Ericsson, Fujitsu, Parallel Wireless; data as of 2022.
6Division of Investment Management, U.S. Securities and Exchange Commission, “Private Fund Statistics: First Calendar Quarter 2023,” October 16, 2023. Top- and bottom-quartile private equity managers, for example, on average, demonstrate a 20% performance differential. In hedge funds, the difference is 14% between top-quartile and bottom-quartile performing managers. Sources: Burgiss (now part of MSCI), National Council of Real Estate Investment Fiduciaries, Morningstar, PivotalPath, J.P. Morgan Asset Management. Manager dispersion is based on the annual returns for hedge funds and global private equity, and represented by the 10-year horizon internal rate of return (IRR) ending 2Q 2023. Data are based on availability as of November 30, 2023.
2Emily Yue, “CRE Mortgage Maturities & Debt Outstanding: $2.8 Trillion Coming Due by 2028,” Trepp, December 21, 2023.
3Source: Green Street Advisors, MSCI, National Council of Real Estate Investment Fiduciaries , National Association of Real Estate Investment Trusts, J.P Morgan Asset Management; data as of September 30, 2023.
4Source: Green Street Advisors, MSCI, National Council of Real Estate Investment Fiduciaries , National Association of Real Estate Investment Trusts, J.P Morgan Asset Management; data as of September 30, 2023.
5Ericsson, Fujitsu, Parallel Wireless; data as of 2022.
6Division of Investment Management, U.S. Securities and Exchange Commission, “Private Fund Statistics: First Calendar Quarter 2023,” October 16, 2023. Top- and bottom-quartile private equity managers, for example, on average, demonstrate a 20% performance differential. In hedge funds, the difference is 14% between top-quartile and bottom-quartile performing managers. Sources: Burgiss (now part of MSCI), National Council of Real Estate Investment Fiduciaries, Morningstar, PivotalPath, J.P. Morgan Asset Management. Manager dispersion is based on the annual returns for hedge funds and global private equity, and represented by the 10-year horizon internal rate of return (IRR) ending 2Q 2023. Data are based on availability as of November 30, 2023.
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