• If concerned about rising interest rates, consider senior loans and market neutral. Senior loans (also known as bank loans) are loans made by banks to non-investment grade companies, commonly in relation to leveraged buyouts, mergers and acquisitions. The loans are contractually senior to other debt and equity, and the yield associated with them tends to be higher than on investment grade corporate bonds. Another key aspect of senior loans is that the interest rate paid is a floating rate that resets every 30 to 90 days. This means that in a rising interest rate environment, as long as the rate rises above a predetermined minimum level, the investor will receive increased payments from the borrower. In addition to senior loans, market neutral funds might make sense given that they typically have minimal exposure to interest rate risk and have a return/risk profile similar to that of bonds.
• If looking for income, consider senior loans and income-generating real assets. For the reasons mentioned above, senior loans have tended to produce attractive yield for investors. Income-producing real asset investments such as infrastructure, MLPs and certain types of real estate investments have the potential to deliver attractive levels of current income for investors.
• If looking to outperform public market stock and bonds, consider private market investments such as private equity, venture capital, direct real estate, direct infrastructure, private credit and natural resources. Unlike the previous types of alternatives mentioned, private market investments are typically only available to high-net-worth and institutional investors. Over the past few years, however, these investments have become more widely available to investors. The defining characteristic of these investments is that they invest in private companies rather than publicly traded companies. Private markets are inherently less efficient than publicly traded companies, and investors seek to generate excess returns, in part, by exploiting the inefficiencies associated with the private markets.
One final word on alternatives: In my view, the most common mistake financial advisors and investors make with alternatives is investing on a reactive basis following a period of gains for the asset class. For this reason, financial advisors and investors might benefit from proactively considering and potentially allocating to alternatives, especially given the current market’s warning signs.
Walter Davis is an alternative investment strategist for Invesco.