The potential benefits of alternative investments
By: Sean Flynn, Head of Alternatives for J.P. Morgan Wealth Management, Vinny Amaru, Global Investment Strategiest
The investing environment of the 2020s has been a notable departure from the 2010s. A regime of higher growth and inflation volatility has revealed shortcomings of traditional mixes of publicly listed stocks and bonds. 2022 was a good reminder that while core bonds could offer a buffer against an equity drawdown driven by slower growth, they struggle to provide protection during periods of faster-than-expected inflation. While we expect 2025 to be a positive year for risk assets, economic uncertainty remains high.
Economic policy uncertainty on the rise
To help build resilient portfolios for the twists and turns that may lie ahead, alternative investments could potentially complement existing allocations. With more companies waiting longer to go public and a meaningful share of business lending being done through private channels rather than public banks, the opportunity set in private markets, and differentiated access to secular themes, has expanded.
What are alternative investments?
Alternative investments encompass a range of non-traditional assets, including private equity, venture capital, infrastructure, direct lending, hedge funds and real estate. These assets often have different risk-return profiles compared to traditional stocks and bonds, providing diversification benefits and potential for higher returns. Alternative investing is considered highly risky and investors should carefully assess these risks and consider their own risk tolerance, investment goals.
Characteristics of specific alternative investments
Alternative assets can come in a variety of forms and below we provide additional details on the characteristics that we would expect from each type of asset.
- Private equity/venture capital: Can provide exposure to high-growth companies and sectors, potentially enhancing returns. We expect that growth equity is poised for a rebound in 2025, with improved demand for deal making and further deregulation.
- Infrastructure: Looks to provide stable, long-term cash flows and can benefit from increased government and private sector spending on infrastructure projects. We anticipate strong demand for infrastructure as the U.S. looks to secure both energy resources and supply chains.
- Direct lending: Can offer attractive yields and can provide a buffer against rising interest rates and inflation, as loans are often structured with floating rates. We expect direct lending to remain resilient, with prudent risk-taking and strong demand.
- Hedge funds: Employ diverse strategies that can capitalize on market inefficiencies and provide downside hedge during market volatility. Hedge funds have the ability to go long and short and can therefore be uncorrelated to financial markets.
- Real estate: Invests in a tangible asset class that can offer income through rental yields and potential appreciation. Real estate can often act as a natural hedge against inflation, as property values and rents tend to rise with inflation
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Alternative investments can provide exposure to secular themes
Beyond diversification benefits, alternative investments can offer unique exposure to secular themes such as:
- Artificial intelligence: AI investment is likely to accelerate due to rapid advancements in AI models and increasing corporate adoption. With corporate capital investment currently low, there is significant potential for increased AI spending as its use cases become more compelling.
- Power infrastructure: We see opportunities as the sector is poised for growth driven by the reindustrialization of U.S. manufacturing, increased electrification in clean energy solutions and demand from data centers.
- Health care innovation: Advances in biotechnology and medical therapies, including AI-driven healthcare solutions, may present growth opportunities.
- Redefining security: The ongoing push to improve U.S. domestic security could provide interesting opportunities in smaller companies focused on innovation in technology-enabled defense systems and cybersecurity.
2022 case study: Alternatives in a rising inflation environment
While a rising inflation environment is not our base case for 2025, renewed geopolitical uncertainty highlights the importance of building portfolios that could withstand a variety of economic environments.
The 2022 inflationary episode provides a helpful case study on the potential benefits of alternative investments. Public assets struggled as the Federal Reserve tightened interest rates to combat rising inflation. Commodities stood out as one of the few public market assets that generated positive returns. What also stood out is the positive return from a mix of alternative investments.
A portfolio of alternative assets generated positive returns in 2022
By adding diversifying assets, portfolio drawdowns could be shallower and allow wealth to compound more steadily over time. Remember, asset allocation/diversification does not guarantee a profit or protect against a loss.
We can help
As always – but especially in alternatives – due diligence and selectivity are essential, as performance can vary widely. It’s important to remember that investing in alternatives often involves a greater degree of risk than investing in traditional assets. For instance, they are typically not registered with regulators and may therefore offer limited information to investors. Additionally, alternatives often carry a risk of illiquidity as a result of restrictions on transfer and lack of a secondary trading market.
Many investors choose to partner with us to narrow the alternative investment universe because of our rigorous scrutiny of managers. Our in-house team conducts on-site visits, examining the structure, operations, incentives and individuals on a manager’s team.
In times of higher uncertainty, building portfolios that can withstand the various, and sometimes sharp, ups and downs becomes even more important. We believe that incorporating alternative investments into portfolios can help mitigate vulnerabilities to volatile inflation environments and also provide early access to emerging technologies and industries. By diversifying beyond traditional assets, investors could achieve more consistent returns and better align portfolios to meet long-term financial goals. If you’re looking to explore adding alts to your portfolio, a J.P. Morgan advisor can help.
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