Alternatives face pressure to integrate ESG into their strategies in 2020

Report highlights opportunities across hedge funds, private equity, private credit, real estate, infrastructure and other real assets, and liquid alternatives

J.P. Morgan Asset Management released January 16 its second annual Global Alternatives Outlook. The report provides a 12-18-month outlook across key alternative asset classes, and offers an assessment of opportunities in alternatives as investors look to construct resilient portfolios in an environment of high public equity valuations and lower fixed income yields.

The 2020 Alternatives Outlook also provides an alternatives framework for investors to build resilient portfolios, by categorizing asset classes according to their role in the portfolio, divided into core foundation, core complements and potential return enhancers.

The report reveals several key findings across asset classes:

Hedge Funds

As tech spending continues across industries, opportunities are expected to arise as digital initiatives go mainstream, fueling capex and rising demand for software and services. Increased application of machine learning will continue having a positive impact on hedge funds.

The year ahead will be a critical year for hedge fund managers to increase the integration of Environmental, Social and Governance (ESG) criteria and sustainability across their businesses and investment activities. The next sectors experiencing sustainability-led disruption include transport, agriculture, automotive, buildings and industrials.

Value is seen as one of the best bets as a rebound is expected to reverse a factor trend prevalent since early 2017. However, a bubble could form among lower quality, higher growth names, so based on investors’ investment objectives and risk appetite, the opportunity could come from selective short exposure, rather than just being long the value factor.

Infrastructure

Although significant capital has been raised for core infrastructure, it is from a relatively low base and private capital remains a small percentage of the market’s overall financing. Equity returns remain attractive relative to other traditional asset classes, particularly on a risk-adjusted basis.

Core infrastructure equity risk-adjusted returns remain attractive on a relative basis, but some investors are increasing their risk tolerance in order to maintain expected returns. Based on their investment objectives, investors should focus on assets that have the ability to provide clear visibility into long-term yield.

A focus on ESG considerations continues to be fundamental and aligns closely with the objectives of infrastructure investments. Renewable energy’s environmental benefits are lifting both supply and demand in the sector, resulting in the availability of long-term contracts aligned with the investment objectives of the asset class.

Transport

In this period of low yields, the core-plus transport sector could be considered as an attractive proposition for investors looking for asset classes with potential for reliable income streams resultant from long-term leases, low leverage and the financial strength of high quality, often investment grade, end users. 

Despite declines in China-US trade volumes, the trade tensions have had a less severe impact on seaborne trade than many had expected. Overall, substitutions in the supply chain have mitigated the impact of the trade tensions.

As of January 1, a new International Maritime Organization regulation requires ships to meet more demanding fuel emission standards. Core-plus investors could consider focusing on modern, fuel-efficient vessels; these are the most attractive to lessees with long-term, ESG focused, transportation requirements.

Private Credit

Amid nervousness about corporate lending, there is demand for exposure to US housing and consumer credit. One popular strategy has been mortgage origination to the self-employed and those who are strong financially but are disqualified by their FICO score.

Other opportunities in private credit in 2020 include longer duration, less-liquid mid cap company debt; distressed lending and nonperforming bank loans including re-performing assets created during loan modifications and restructurings, or purchased at a discount after an issuer’s creditworthiness is re-rated; commercial mortgage loans such as core, high-quality multi-family, industrial and office lending in the US Southwest and West.

Private Equity

While corporate finance deals are increasingly competitive, there are attractive opportunities in firms with revenues of US$10 -$100 million. These investments tend to stay below the radar and be less leveraged, with less inflated valuations than more prominent deals.

With innovation most likely to emerge from smaller, lesser-known, private enterprises, high-growth opportunities will be difficult to find. E-commerce, cybersecurity, and software-as-a-service (SaaS) are a few areas that continue to see tremendous promise.

Real Estate

Extended core sectors are making up an increasing share of private real estate allocations in the US as investors come to better understand these opportunities. Single family rentals, biotech, self-storage and data centers are the preferred areas for opportunity.

When looking for income and diversification, two sectors are favoured: high-quality, well-leased multi-family properties, generally outside of the super-luxury apartment sector, and stabilized multi-tenant office buildings in established markets exhibiting strong employment growth.

Overall, modest economic growth, low vacancy rates and limited new supply should support rental growth in major European markets. Investors are becoming more active in extended core sectors. However, since many of these sectors are in their infancies in Europe vs the US it may take longer for these core opportunities to become accessible in Europe at scale.

APAC appears to be at a slightly earlier stage of the economic cycle vs the US and Europe. APAC core real estate returns and the diversification opportunities the market can provide are attracting investors’ attention globally. Some diversifying opportunities exist in logistics, core office markets and multi-family markets.

Date

16 Jan 2020

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