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What are alternative investments?
Alternative investments are assets that sit outside of a normal stock and bond portfolio. At Arbuthnot Latham, we aim to retain some liquidity and so mainly allocate to alternatives such as hedge funds, commodities and property. Alternatives can also include opportunities such as art, classic cars, private equity and farmland, to name a few. These latter investments are much less liquid and can be more difficult to access, and so are often self-managed personally by investors rather than by us.
How do alternative investments differ to mainstream investments such as stocks and bonds?
Typically, alternative investments will offer a type of exposure and return profile that is different from your traditional stock and bond, which can help diversify risk. Many alternatives are also less liquid and so will take longer to realise than traditional stocks and bonds.
What are the potential benefits and risks of investing in alternative asset classes?
Top of the list of benefits is diversification i.e. how they behave against other assets in a portfolio to either protect or grow investor wealth. For example, in 2022 when stocks and bonds performed poorly, alternative investments were very resilient. Depending on the investment, they could offer higher return potential when compared to traditional assets and a number of alternatives have been seen to offer protection against inflation over time as well.
On the flip side, for that additional return from alternatives, you will likely need to take higher risks. Generally, alternatives will have higher fees or transaction costs associated with them, which speaks to their potential complexity and/or illiquidity, which are also key risks.
What does the alternatives landscape look like today? Have the rising interest rates had an impact on alternative investments and investor behaviour?
The starting point for almost all investments is interest rates as they have such a fundamental impact on the global economy, and by extension almost all investable assets. This was the case in 2022 when both stocks and bonds fell in response to rising interest rates and other adverse factors. Many alternatives were also negatively impacted, although these were normally investments with tangible links to interest rate sensitivity.
On the flip side of this, several alternatives performed exceptionally well where their value was more closely linked to inflation, the cause of higher interest rates. Commodities have performed exceptionally well, having been the driver of much inflation over the last three years.
The main impact rising interest rates have had on all investments is the amount of additional return you might expect above cash rates to compensate for the additional risks you might take. For example, the expected returns in many types of hedge funds is now uncompetitive with cash. Most investors are now comparing potential returns to cash, which can be very dangerous as one factor that has been shown time and time again is that over the long term cash lags all other asset returns and generally fails to keep pace with inflation.
What are your short, medium and long term outlooks for the UK economy? How do you see alternative investments factoring into this?
We will start by caveating that Arbuthnot Latham invest globally and so while factors for the UK economy are very important for our clients, we need to consider a much wider set of factors when considering traditional and alternative investments. That said, the UK is one of the more sensitive economies to rising interest rates which makes it more vulnerable over the next 2 – 3 years. This is driven by how higher interest rates filter through to the economy.
As opposed to the US and many parts of the EU, the makeup of the UK mortgage market is much shorter in duration with two to five year fixed mortgages being very prevalent. This means that over the next five years close to 100% of mortgages are set to refinance and the high interest costs will act as a redistribution of disposable income away from discretionary spending.
The extent to which other factors can offset this drag is yet to be seen and will depend to a large degree on how the global economy performs. Alternative assets that can perform well through this period of higher rates and potential economic softening is likely where you would want to be positioned.
How should an investor approach real estate when building a portfolio of investments?
When it comes to a portfolio, the key is to get the sizing and type of exposure correct. Think about the expected returns and risk of property relative to the other assets that are available to invest in. For private investors this would typically be the additional yield over cash rates or debt servicing costs that are achievable.
Our exposures will be highly diversified, though we still look to consider the sectors of the property market we are gaining exposure to and think about the structural headwinds, tailwinds, and opportunities. Recently this has led us to have preferences for prime over secondary, though if you are an investor buying a direct property there will likely be a greater focus on idiosyncratic factors of the property such as the location, and potential upgrading to increase the value or yield.
Finally, decide whether this is a long hold or more of a turnaround/market opportunity. Ultimately, property is a less liquid investment with higher transaction costs and so due diligence and conviction behind allocations should be well thought through to maintain the holding should the market moves in an unpredictable manner.
If you’re looking to grow your finances through property, we can help achieve what’s important to you. Reach out to us today to start building your future with an investment that stands the test of time.
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