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J.P. Morgan Asset Management’s new Global Alternatives Outlook report, released Wednesday, assesses opportunities in alternatives as investors look to construct robust portfolios in an environment of high public equity valuations and lower fixed income yields.

“In this delicately balanced investment climate, investors should increasingly consider the role alternatives can play as both a diversifier and a potential source of steady income without adding to a portfolio’s equity risk,” Anton Pil, global head of alternatives at J.P. Morgan Asset Management, said in a statement.

The report categorizes asset classes according to their role in the portfolio, divided into three basic components:

  • Core foundation: assets such as core real assets and core private credit to provide stable income with lower volatility
  • Core complements: assets such as hedge funds to add diversification and uncorrelated alpha
  • Potential return enhancers: assets such as special situations and private equity to seek opportunistic return

Hedge Funds

According to the report, spending on tech continues across industries, increasing opportunities as digital initiatives go mainstream, such as the buildout of public 5G networks. This will likely fuel capital expenditure and increase demand for software and services. Increased application of machine learning will continue to have a positive effect many industries, including finance and hedge funds.

In 2020, it will be essential for hedge fund managers to increase integration of environmental, social and governance criteria and sustainability across their businesses and investment activities, the report says. The next sectors to experience sustainability-led disruption include transport, agriculture, automotive, buildings and industrials. Investing in sustainability will be crowded, making manager selection crucial. Active investors will be able to take full advantage of the theme across industries, through long and short exposures in different asset classes.

J.P. Morgan asset managers say value, which has become very inexpensive, is one of their best bets as they expect a rebound to reverse a factor trend prevalent since early 2017. They see a bubble building among lower quality, higher growth names, so based on investors’ objectives and risk appetite, the opportunity could come from selective short exposure, rather than just being long the value factor.

Infrastructure

The significant amount of capital raised for core infrastructure has come from a relatively low base, and private capital remains a small percentage of the market’s overall financing. The report says equity returns remain attractive relative to other traditional asset classes, particularly on a risk-adjusted basis.

But even as core infrastructure equity risk-adjusted returns remain attractive on a relative basis, some investors are increasing their risk tolerance in order to maintain expected returns. J.P. Morgan says that based on their investment objectives, investors should focus on assets that can provide clear visibility into long-term yield.

A focus on environmental, social and governance considerations is fundamental and aligns closely with the objectives of infrastructure investments, the report says. 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 the current low-yield environment, the report says the core-plus transport sector is an attractive proposition for investors looking for assets classes with potential for reliable income streams resulting from long-term leases, low leverage and the financial strength of high-quality, often investment-grade, end users.

The report notes that despite declines in China-U.S. trade volumes, trade tensions have hurt seaborne trade less severely than many had expected as substitutions in the supply chain have mitigated their effect.

As of Jan. 1, a new International Maritime Organization regulation requires ships to meet more demanding fuel emissions standards. J.P. Morgan Asset Management says core-plus investors may want to focus on modern, fuel-efficient vessels, which are most attractive to lessees with long-term, ESG-focused transportation requirements.

Private Credit

Amid nervousness about corporate lending, demand exists for exposure to U.S. 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.

The report says investors also see these opportunities in private credit in 2020:

  • Longer duration, less-liquid midcap company debt
  • Distressed lending and nonperforming bank loans
  • Commercial mortgage loans

Private Equity

Corporate finance deals are increasingly competitive, but relatively attractive investment opportunities exist in firms with revenues of $10 million to $100 million, according to the report. These tend to stay below the radar and be less leveraged, with less inflated valuations than more prominent deals.

Innovation is most likely to emerge from smaller private enterprises, so high-growth opportunities will be hard to find. The report says areas that continue to show promise are e-commerce, cybersecurity and software-as-a-service.

As investors increasingly focus on ESG dimensions, J.P. Morgan Asset Management uses an established approach to incorporate those factors into its investment process and help portfolio companies and managers it invests with to consider them in their own business and investment practices.

Real Estate

U.S.: As investors get a better handle on extended core sectors, these are making up an increasing share of private real estate allocations. J.P. Morgan Asset Management’s preferred opportunities are single family rentals, biotech, self-storage and data centers.

In the search for income and diversification, it favors two sectors: high-quality, well-leased multifamily properties, generally outside of the super-luxury apartment sector, and stabilized multi-tenant office buildings in established markets exhibiting strong employment growth.

Europe: Modest economic growth, low vacancy rates and limited new supply will likely support rental growth in major European markets, where investors are becoming more active in extended core sectors, according to the report. However, it may take longer for these core opportunities to become accessible at scale since many of these sectors are in their infancies, compared with the U.S.

Asia/Pacific: Asia/Pacific appears to be at a somewhat earlier stage of the economic cycle, compared with the U.S. and Europe, the report says. The region’s core real estate returns and the diversification opportunities the market can provide — logistics, core office markets and multifamily markets — are attracting investors’ attention globally.