Advisors looking to add alternatives to client portfolios right now would be wise to consider four areas in particular—private credit, infrastructure, the secondary market for private equity, and multi-family real estate, according to a panel of investment experts.

Speaking at the Investments & Wealth Institute’s “Focus on Alternatives” conference last week in New York, Apollo Global Management director Diana Sands and Benefit Street Partners president Rich Byrne noted that public-market stocks and bonds sometimes move in lockstep, which means investors need something to further diversify their portfolios. They added that putting alts in a portfolio is a way to both goose returns and dampen volatility.

For example, the traditional 60% equities/40% bonds portfolio has an annualized return of 8.5% with annualized volatility of 9.6%, according to Apollo data. A 50% equities/20% bonds/30% alternatives portfolio has very similar volatility of 9.5% but a higher return of 9.5%, the firm said.

Meanwhile, a 30% equities/40% bonds/30% alternatives portfolio has the same return of 8.5%, but its volatility drops to 6.5%.

“For many investors, if you think alternatives, if you think private markets, you immediately think ‘high risk, high return.’ That doesn't have to be the case. Risk-adjusted returns. Excess return per unit of risk. That's what we're after,” Sands said.

The big question when it comes to private markets is not risk so much as liquidity, she said, if these investments are being compared with public markets.

“You can have safe and risky public markets. You can have safe and risky private markets. The biggest defining feature is liquidity,” she said. “One is daily traded, the other is not.”

Good private equity fundamentals require strong cash flows from the companies you’re invested in and room for improvement in their operations, she said. When it comes to private credit, the best fundamentals are high cash flows and your seniority in the capital structure. You should also be selective about the company issuing the debt.

“Every credit manager on the globe has been for the last 18 months, 24 months, saying it's the golden age of credit. Why are they saying that?” she asked. “Interest rates are higher. And so you can clip a nice, easy, low-double-digit, high-single-digit return in private credit today, earning a little bit more relative to public comparables.”

That being said, earning more is a double-edged sword, as someone is paying for that higher interest rate, and that’s the company, she said. Not only does the company’s balance sheet have to support its debt payment, it has to do so under a variety of market conditions.

From that standpoint, she said, when her team looks at private credit issuers, they will look more at large-cap-oriented, bigger companies that can sustain and survive a downturn. They’ll also look for deals in which, as investors, they can stay higher in the capital structure. She added that the long-run return for private credit is in the high single digits.

Inflation-Resilient Infrastructure
Another alternative sector that looks good to Sands and her team is infrastructure equity investments. She likes it for two main reasons. First, roads are horrible, and, second, infrastructure investing is resilient in times of inflation.

According to her data, the United States is at 100-year highs in terms of aging infrastructure. And it’s not just a U.S. problem but a global one, something that needs $90 trillion to fix.

“There’s just a huge need for capital to support ongoing infrastructure maintenance,” she said. “And think about a toll road. Inflation goes higher, and [toll authorities] can just reset those. A lot of infrastructure assets have inflation-linked contracts that boost the cash flow. You have a real path through inflationary dynamics.”

And infrastructure is not just a cyclical asset class—its investors are buying assets that are necessary to the daily functioning of the economy, she said.

“It’s roads, bridges, ports, critical transportation logistics. It’s data centers,” Sands said. “It’s cell towers getting us all online and communicating.”

Data center infrastructure will become increasingly important with the proliferation of AI. Sands noted that the average ChatGPT search uses 10 times more data power than a Google search.

Secondary PE Market Grows
Last but not least among Sands’s favorite alternative investments is the secondary market for private equity. The primary market for private equity has had a hard time performing in the last few years because of a higher cost of capital, coming at a time when valuations are higher, she said. That means managers have been struggling to put capital to work—and they’ve had a lot of trouble exiting their deals.

“Exits on private equity transactions from 2021 to 2024 are down 70%, because you have to find the next person who’s going to pay,” she said. “Who's going to pay the higher interest rate, and [give you the fair] valuation that you want?” All those factors have meant “the market has really slowed materially.”

Secondary market private equity, however, though still just 1% to 2% of the private markets, has continued to grow.

“Maybe you’re not thrilled with the current market environment, the headwinds facing primary private equity. Entering into the secondary market has actually been an interesting way to get that exposure,” Sands said.

Doing Well In A Hurricane
Byrne talked about finding value in commercial real estate, specifically multi-family buildings.

“The best relative value for probably the last four or five months, and I think is going to continue to be the answer for the next four or five months, maybe the next three to five years, is commercial real estate lending,” he said.

The reason, he said, is that values have been beaten down by higher interest rates and institutions’ need to refinance. That presents a buying opportunity. He referred to what’s happened as a “hurricane.”

He leaned into an analogy from the movie Forrest Gump, where the lead character buys a shrimping boat but struggles to catch shrimp because all the good fishing grounds are taken by the major, established shrimping companies. Then a hurricane damages those boats and the small, agile boat owned by Gump gets to catch shrimp all day, unchallenged.

Byrne says it’s similar to what’s happened to $4 trillion in real estate loans, half of which were underwritten by banks and half underwritten by large financial institutions. When interest rates rose high and quickly, there was an inverse effect on asset values, Byrne said.

“It didn't matter what kind of property you underwrote, the cost side of your equation increased so much, your property value was down by 20% to 25%, on average,” he said. “I don't care if it was multi-family, a hotel, or retail. It was down just because of interest rates, materially, 20% to 25%.”

While office space, still reeling from a post-pandemic world and shifts to remote work, is a poor investment, he said, other areas of commercial real estate have been deeply discounted in refinancing deals.

In fact, over the last nine months, Benefit Street has invested $1.7 billion of capital into new loans, Byrne said.

“These are some of the best deals we've underwritten in years,” he said, adding that multi-family properties, which he considers “the port in the storm,” are currently trading at capitalization rates of 5%.

“We’re certainly now at about 75% multi-family. There’s still a shortage of housing in this country,” he said. “And every time we've sold one, there's been a line—25 bidders plus. So from our standpoint, multifamily is the place to go.”

This is the second of two articles summarizing presentations at the Investments & Wealth Institute conference. The first was “Alts Can Buoy And Protect A 60/40 Portfolio, Experts Say.”