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With bonds and equities becoming fickle friends

European investors are assessing the alternatives


Cherry Reynard

At the recent virtual Association of the Luxembourg Fund Industry (Alfi) conference, investors made it clear that they believed Europe to be the next growth hotspot for alternative assets, with growth slowing in the previously buoyant US market.

But can European investors be weaned off their traditional mix of bond and equities?

Fickle friends

Few defend the traditional 60/40 equity/bond allocation model today. At a time of loose monetary policy, the diversification benefits of holding equities and bonds have weakened and correlations have shifted.

For example, the technology sector has been a significant beneficiary of a falling ‘risk free’ rate, brought about by lower government bond yields.

Equally, with government bond yields at historic lows, investors can no longer rely on the protective effect of fixed income.

Low yields also mean they are little use for income seekers, who need to look elsewhere – and often to higher risk assets – to support their portfolio income.

This makes a strong case for the inclusion of alternatives in a portfolio, but Ucits sales have still outpaced those of Alternative Investment Funds (AIFs) by some margin for the year to date – €202.7bn versus €69.1bn – with a growth rate of 1.4% versus 0.8% (Efama).

That said, AIFs have shown steadier growth – almost all the inflows into Ucits have come in the last two months as investors have grown more comfortable with markets once again, whereas AIF flows have been more even across the past six months.

Different motives

Paul Bashir, chief executive at Harrison Street, says that alternatives have seen a lot of positive momentum both pre- and post-coronavirus, but the motivation in each case may be very different: “Pre-covid, investors were looking for an alternative return profile, away from core, traditional asset sectors.

“The focus was on higher return-dynamic funds, though many were also looking for diversification. Post-covid, some alternative sectors came under pressure – many real estate asset classes have been under pressure, for example. But some have come out very strong.”

Post-covid investors are more likely to be looking to alternatives for their defensive and diversification qualities, rather than their growth potential. The trend in private equity illustrates this point.

Private equity had been a popular option to boost returns in the run up to the crisis, as returns from conventional equity and bond markets looked unexciting.

However, inflows sank abruptly as the pandemic hit. For example, private equity investment slumped 67% in Spain in the first half of this year, which had been a hotspot up to that point.

Not immune

Areas of the commercial property market have also looked vulnerable and seen investors move into areas with better prospects. Jim Barry, chief investment officer of BlackRock Alternative Investors, agrees that alternative assets have not been immune to the problems created by the coronavirus and this has affected demand in some cases.

“There can be no question that covid has had a negative impact. In property, for example, we have seen rents fall off dramatically in some areas: the biggest impact has been in retail, with falls of up to 60% in rent due. However, it has been better in industrials and multi-family residential property has been the best performing.”

Overall, there has been a notable shift away from equity and multi-asset alternative investments, towards specialist real estate, bonds and ‘other’.

Bashir says he is starting to see positive demand around areas such as student accommodation and life sciences as investors adjust to a shifting world. That said, he believes investors are still looking at the trends around covid and trying to figure out whether they are temporary or permanent.

Discipline needed

Barry thinks they are right to be patient.

He believes there will be marked winners and losers across geographies and sectors and investors need to be sensitive to that. On the one hand, in property there has been an acceleration of existing trends. Ecommerce trends have dented the high street, which in turn brings huge opportunities in logistics.

“Working from home is now with us. It is not going to stay the same once we get the virus under control….but this massive experiment has implications for how we use space in offices and also at home.”

He says investors need “discipline and patience” as these new trends play out.

The private equity market is also likely to change.  Barry sees a greater focus on restructuring rather than the ‘cost control and leverage’ deals that were happening pre-covid, though he still sees a place for growth assets.

Equally, there are some areas that should be popular in a crisis but have not attracted investor interest. For example, flows into hedge funds sank in the first quarter, revived somewhat in the second quarter, but significant redemptions pushed the industry into overall net outflows.

Investors remain to be convinced of their success in delivering absolute returns.

Just as financial markets are in flux, so are many alternatives markets. This is seeing investors pause before making significant decisions on where to commit capital.

The pandemic should ultimately create greater demand for alternatives, but it will take time to work out the likely beneficiaries.