Economic headwinds should lead to higher market volatility in 2019, but this could create opportunities for those who use alternative investments wisely, according to J.P. Morgan Asset Management.

Alternative investments will allow investors to execute both offensive and defensive strategies to contend with high volatility by "focusing on assets that generate stable streams of income and strategies that benefit from the disruption that rising volatility creates," the unit of JPMorgan Chase & Co. said in an inaugural global alternative outlook report released on Wednesday.

The report concluded that the U.S. economy is in "late cycle," which typically means that growth is slowing and that a recession could be looming. But analysts at J.P. Morgan Asset Management said that, nonetheless, "we believe that both the economy and markets still have room to run." They predicted that U.S. economic growth will average about 3 percent through the first six months of the year.

"It seems unlikely that 2019 will mark the end of the current economic expansion, but clearly risks are beginning to build," the report stated. "We do not believe this is a reason for investors to move to the sidelines but rather an opportunity to ensure that portfolios are prepared for the unexpected as well as the expected."

The firm's analysts gave the following breakdown on how investors can use the following alternative asset classes:

Hedge Funds

"All else being equal, an increase in market volatility helps generate trading opportunities, and several hedge fund strategies stand to benefit as volatility prompts the relationship among stocks, rates and credit spreads to evolve, affecting prices and correlations," the report stated.

Hedge funds can take advantage of volatile markets by taking long and short positions and by focusing on uncovering short-term inefficiencies, the firm's analysts said. "Those qualities may prove advantageous in the coming year, as fundamentals will likely do more to set valuations and as price dispersion likely grows," they said.

Analysts also predicted that value stocks will rebound in 2019, which could also benefit hedge fund investors.

Infrastructure And Transport

Investors need to be keenly aware of the impact that ESG strategies are having on this sector, analysts said.

"Private infrastructure investing has reached a tipping point," the report stated. "The integration of environmental, social and governance (ESG) standards is now mainstream, a forward-looking matter of strategic positioning rather than the backward-looking compliance consideration of the past."

In the area of transportation, the analysts said the best opportunities will be in what it calls the "core-plus transport" sector, the segment of the industry comprising large dry bulk carriers, ultra-large container ships, tankers, liquefied natural gas carriers, very large gas carriers, aircraft and railcars. Long-term leases and healthy balance sheets in this area help mitigate risk, the report said.

Private Credit

"Pockets of opportunity exist," the analysts said. "Parts of the corporate credit market appear stretched, and this requires a cautious approach. Still, not all areas of private debt are overheating. Attractive loan origination opportunities still exist, with examples including real estate mezzanine debt, U.S. residential mortgages and corporate loans."

Distressed and special situations private credit strategies are also well positioned for an economic downturn, the report said.

Private Equity

Investors have been turning to private equity for nearly a decade in search of alternatives to a traditional market that has offered only modest returns, the JPMorgan analysts said. This buildup in private equity capital, however, has made it harder to invest the funds effectively.

"Demand outpacing supply generally means higher valuations, greater use of leverage and/or lower potential future internal rates of return," the report said.

That means investors have to be particularly discriminating in this sector.

"Investors have three choices: [to] lower [their] return expectations, sacrifice underwriting standards or be disciplined in seeking out solid opportunities in this late cycle with the potential to deliver on private equity risk and return objectives over the long term," the report stated.

The firm's analysts said opportunities may be found in small to midsize companies; Europe, China and, selectively, India; and businesses benefiting from technological disruption.

Global Real Estate

"Finding value requires looking beyond the averages," the report stated. "Regional markets are at varied stages of the economic cycle and monetary policy normalization. These differences, and a host of distinct dynamics across and within regions, styles and sectors, create pockets of opportunity that can help investors diversify and enhance real estate portfolio income and return."

Analysts said Asia-Pacific real estate may hold opportunities with economies in midcycle. They also recommended the use of REIT debt to address volatility.