Investors who didn’t own the Nifty Fifty lagged the market. Such momentum-driven runs in equity markets usually fade away within a decade, Clough maintains. “At the end of these growth periods, the largest companies come up against two problems, the first being the base effect: Their capitalization becomes so large that it becomes difficult to move the needle,” he says. “The other effect is regulation. People, including government agencies, take a closer look. This looks like it’s starting to hit the FANG stocks.”
After the fall of the Nifty Fifty in the malaise of the 1970s, the S&P 500 lapsed into decade-long doldrums, while many active funds were able to outperform the index. More recently, the growth of indexed mutual funds and ETFs resembles the rise of the Nifty Fifty. “For the past 10 years, if you weren’t overweight the FANGs, you were probably underperforming,” Clough says.
That scenario may be ripe for change. Low interest rates around the globe, including in the U.S., may push income-oriented investors into alternatives, Lake says.
“In terms of low rates globally, interest rates have fallen to historic lows. We now see negative yields on record amounts of government debt worldwide,” Lake says. “The consequence for investors is that yields on many income-oriented investments may not be sufficient for investors to meet their objectives, particularly for retirees and retirement plans.”
The shortage of yield is already causing investors to shop around for new places to park their money and draw a passive income, Clough argues. Low or negative yields in Europe and Japan have caused many investors in those parts of the world to look to U.S. government and corporate debt as a haven.
As yields on U.S. Treasury and corporate bonds fall, a larger pool of investors is likely to seek income in the equity markets. However, many equity indexes, like the S&P 500, offer investors yields as low as or lower than low-risk fixed-income investments, notes Clough. “There will be demand for active strategies that can focus on yield, or on growth and yield.”
All of those assets pouring into stocks make passive equity market investing more difficult, says Lake, because valuations are becoming stretched.
“Low rates have driven investors into riskier assets,” Lake says. “Now, valuations for many risk assets have reached historically high levels. Price insensitive buyers, which can include passive investors, ETFs and government-related entities, are exacerbating the valuation abnormalities.”
With valuations high and interest rates low, market disruptions become more of a central concern for investors, Lake says. “What goes up can go down,” he says. “Trade and geopolitical tensions, the rise of populist discontent around the world—all of this can unsettle or disrupt globalization, world economies and financial markets. The other mounting pressure, in terms of disruption, stems from rising corporate and government debt levels. All these forces combined leave financial markets and economies vulnerable to policy errors and sudden drawdowns.”
Yet another catalyst for alternative investments is that they have become democratized thanks to technology, product design and regulation, all of which combined offer investors more access to these investments. “It’s probably a good thing to give all investors opportunities to access different markets,” Alitovski says. “It’s important that every investor is educated on the strategies they’re investing in.”