An imminent big-milestone birthday has the Brilliant Investment Group (BIG) executive chair thinking about what he’d like to see this year.
Bringing together our insiders community to share perspectives, debate strategies, and refine their approach to portfolio construction is always an enlightening exercise.
An alternatives lens: What to do with a problem like liquidity
The dominance of private credit, the resurgence of hedge funds, and the search for new sources of diversification have sparked intense debate. Should investors embrace illiquidity for the sake of higher returns? How do they distinguish genuine innovation from opportunistic band-wagoning?
A shifting investment landscape
Andrew Garrett, investment director at Perpetual Private, reflects on the unexpected resilience of markets over the past two years. “You might remember that at the start of 2023, 80 per cent of economists expected a recession within two years. Not only hasn’t it come, but we’ve seen strong returns across most asset classes,” he noted. Despite this, Garrett acknowledged concerns around market fragility, cautioning that the current environment warranted careful positioning. “We feel like there’s going to be a directional move, but we can’t be sure which.”
Iain North, head of alternatives at JANA, provided a contrasting perspective, highlighting a “pro-growth environment” in the United States despite political uncertainty. He emphasised the need for balance when considering alternatives, given the availability of attractive yields in traditional asset classes. “Investors and wealth advisers can now get five to six per cent yields in cash and bonds, which means we have to think carefully about the liquidity trade-offs in alternative investments.”
Selecting the right strategies
A key theme in the discussion was the rigorous due diligence required when selecting alternative investment strategies. Chetan Trehan, sector head of alternatives, real assets and multi-sector at SQM Research, underscored the importance of assessing manager experience, team quality, and diversification, particularly in private credit. “We have concerns with some of the managers in the sector, especially those who are not well-diversified. A portfolio of just 20 loans should not be rated the same as one with 200,” he argued.
Garrett echoed these sentiments, pointing out the risks posed by an influx of new entrants into alternative markets. “There’s a lot of innovation, but that also opens the door to those who don’t fully understand the risks. Our fear is a scenario where an event in one of these funds triggers a panic, leading to broader industry repercussions.”
North added that one of the most valuable due diligence tools was reference-checking. “We always ask for three or four professional and personal references. A pitch book can be fabricated, but industry reputation tells the real story.”
The liquidity conundrum
Liquidity remains a pivotal concern when allocating to alternatives, with investors navigating structures ranging from daily-traded funds to those with decade-long lock-ups. Garrett pointed out the paradox of trying to bring liquidity into inherently illiquid asset classes. “Illiquidity isn’t a good thing unless you’re being rewarded for it. In some areas, like private credit, demand is so high that you’re not getting enough of a discount to compensate for giving up liquidity.”
North warned of the risks associated with some liquid private equity structures emerging in the market. “You’ve got US firms launching liquid private equity funds with 2.5 per cent quarterly redemption gates (that is, 2.5 per cent of the fund’s assets may be redeemed per quarter) while offering weekly liquidity. It’s reminiscent of the pre-2008 period when investors underestimated the risks of certain structured products.”
Trehan stressed the importance of transparency in liquidity assessment. “From a research perspective, we make sure investors are fully aware of liquidity constraints. As long as they understand the risks, it becomes a matter of portfolio construction.”
Opportunities in alternatives
With private credit dominating discussions in recent years, other areas are now poised for a resurgence. North pointed to hedge funds and long/short strategies as beneficiaries of rising market dispersion. “Passive investing thrived in a low-volatility, easy-monetary-policy world. Now, with interest rates higher, we’re seeing attractive returns in long/short strategies due to greater differentiation in stock performance.”
Garrett also noted that while private credit remained compelling, investors needed to be discerning. “We’ve been allocating to private credit for seven years, and while there are great opportunities, the sheer volume of new entrants means there’s more risk of poor underwriting.”
Trehan highlighted structured insurance-linked securities (ILS) as an area of growing interest. “They’re offering 12 per cent returns, providing a significant premium over investment-grade credit. Given their defensive characteristics, they’re worth consideration in the current environment.”
Role in portfolios
A perennial question for advisers is how much to allocate to alternatives. Allocations range widely, from under 10 per cent to more than 50 per cent, making it difficult to establish a universal baseline.
Garrett stated that Perpetual Private typically works off a 15 per cent baseline but stressed that allocations must be tailored to individual circumstances. “If a client has a long-time horizon, they can take on more illiquidity. But if they may need access to capital, you have to be conservative.”
North reinforced the point, noting that some of the world’s leading institutions allocate heavily to alternatives. “Yale and Harvard (that is, the universities’ endowments) have around 20 per cent–25 per cent in hedge funds alone, plus property and private credit. The Future Fund sits at 18 per cent. These investors see the benefits of high-Sharpe-ratio strategies, and access to top-tier managers is improving for private wealth investors.”
Trehan concluded by highlighting that successful alternative investing requires a combination of expertise, patience, and risk management. “Advisers must be diligent about strategy selection, liquidity assessment, and diversification. If done right, alternatives can play a crucial role in enhancing portfolio resilience and returns.”
These insights were captured through the adept questioning of Sinead Rafferty, head of investment sales at Colonial First State, during The Inside Network’s Alternatives Symposium. While macroeconomic uncertainty persists, investors have a growing array of opportunities at their disposal. However, success in the space hinges on robust due diligence, an understanding of liquidity constraints, and careful portfolio construction. As North aptly summarised, “Alternatives aren’t ‘alternative’ anymore – they’re a fundamental part of modern portfolio management.”
