It’s no secret that investors are hailing the U.S. residential real estate market as the new alternative asset class. By asset class, they mean a group of securities or things whose value rises and falls together, and that theoretically rise and fall independently of other asset classes. But definitions are fuzzy. When you talk about asset classes, you might include international equities or emerging markets, along with U.S. stocks, bonds and cash. Others might include infrastructure or impact investing. “SWAG,” or silver, wine, art and gold, has gotten some buzz as an asset class. My definition includes commodities and real estate (traditionally, that has meant the commercial kind), and I am also looking at illiquid credit to broaden my portfolio. The point is, there’s continuous debate about what constitutes an asset class and which asset classes will thrive.
Let’s take a look at two of these possible newcomers to the alternative asset class family: illiquid credit and residential real estate. Both can trace their evolution from niche investments to potential asset classes back to the 2008 financial crisis. When millions of homes were foreclosed on, single-family homes became affordable to opportunistic investors like hedge funds and private equity. Meanwhile, the opportunity to invest in illiquid credit was widened by tough post-2008 regulations requiring banks to hold more capital and higher quality assets.
As banks relinquished their historic role making what are, in effect, private loans to businesses, pension funds and asset management firms have stepped in to fill the gap. For investors looking for higher returns than those of government bonds, illiquid credit is an option, but one with risk trade-offs. In exchange for higher yields, they must be willing to not only accept lower rated paper, but also give up liquidity. Unlike bonds issued by Fortune 500 companies, these loans are not traded in the public market.
Is this new asset class here to stay? It’s possible, but illiquid credit has been a profitable business for banks in the past, and as their balance sheets recover, they may reclaim their role.