Alternatives are the solution

Alternatives are the solution

Low interest rates have been a tailwind for Alternative assets over the last 20 years. Once considered a complementary investment to a traditional fixed income and equities portfolio—and concentrated amongst the largest institutional investors, Alternatives today are an essential and growing part of most investment portfolios. The trend is also accelerating as a result of the recent moves to even lower rates and by the broad range of investments and products across Alternatives now available to investors.

As demand for Alternatives has grown, so too have the breadth and variety of investment offerings. Twenty years ago, investments in Alternatives represented roughly 5% of institutions’ investment portfolios and were largely concentrated in hedge funds and private equity. Today, that number is closer to 25%. Over the same period, the number of investible strategies has grown significantly with the emergence of private credit and real asset investing (real estate, infrastructure, and renewable energy, as examples). Going forward, our clients tell us that these allocations are increasing towards 60%.

The benefits of real assets in a normal economic environment are clear: they offer stable yield underpinned by high-quality contracts. The investments are often private in nature—and are therefore not subject to mark-to-market volatility—and returns are inflation-protected. A low-interest rate environment amplifies these benefits, and is now forcing more investors to either consider Alternatives for the first time or increase their existing allocations.

The reason for this is simple; pension plans, sovereign wealth funds, insurance companies, and many other investors have medium to long-term risk adjusted return targets that can’t be satisfied in the public equity and bond markets. A decade ago, an investor could hold a 10-Year German Treasury bond and earn a 4% yield; today the return stands at negative 1%. And while a select few large institutional investors have built out direct real asset investing capabilities, all have seen the benefits of partnering with asset managers like us who are able to leverage investment expertise and operating scale to drive investment performance and provide access to quality assets.

Across Alternatives, there are many categories of investment across the risk-return spectrum, and these numbers continue to grow to meet the demand of clients. Today we offer private investors over 15 different strategies across five different asset classes, which enables them to build a balanced real asset portfolio that can be tailored to meet their investment objectives. Our listed affiliates are an amalgam of these for public market investors. Beyond the traditional flagship funds, we offer our clients perpetual core private funds, private debt funds, listed credit products and region-specific funds. As we have grown, we have attracted new clients, and their commitments to our funds have grown, as has the average number of funds our clients invest in. From our own experience, it is clear that the allocation to Alternatives is growing faster now than it ever has, and we don’t see any reason for it to slow down.

With interest rates likely to be anchored at close to zero for the next several years, we expect this will also translate into strong support for asset valuations. Our partner, Howard Marks, recently published a letter titled “Coming into Focus” that discusses in depth how lower risk-free interest rates increase asset valuations, which we encourage you to read. We are at the very early stages of this playing out in the private markets, but as transaction activity returns, we fully expect to see higher valuations for the best assets. The recent sale of one of our office buildings in London at 10% higher than the price we paid for the property 12 months ago is a perfect illustration of this point, where lower interest rates increased the discounted cash flow value of the asset. While it could take time for transaction activity to fully ramp up, and contrary to the sentiment that has existed in the market, this sale provides us with clear evidence that the high-quality real asset portfolio we own is today worth even more than it was just nine months ago. 

Bruce Flatt

Chief Executive Officer

Brookfield Asset Management Inc.

November 12, 2020