As 2022 begins there’s plenty to be cautious about. Central Banks are starting to tighten monetary policy, energy prices are contributing to rising inflationInflationThe rate at which prices increase over a period of time. read more, economic growth is being impacted by Covid-19 variants and US midterm elections are scheduled for November. This is all happening against a backdrop of record high stock markets whose valuation, from some perspectives, could be compared to the 2000s internet bubble. We also have record-breaking temperatures:
2021 being confirmed as the 6th hottest year on record; the last 7 years being the hottest ever recorded.
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So, what effect could all these events have on different asset classes? Rising inflation and interest ratesInterest rateThe fixed return investors receive on debt securities. Usually refers to the rate set by Central Banks from which other debt instruments are valued. read more can be challenging for fixed incomeFixed incomeAn investment that pays a fixed amount of interest like a bond and typically aims to preserve capital. read more as an increase in rates can erode the value of the payments received. A way to reduce this effect could be lowering durationDurationA measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. The longer the duration the greater the sensitivity. read more, or the average time to maturity of the bonds in the portfolio to reduce the sensitivity to changes in interest ratesInterest rateThe fixed return investors receive on debt securities. Usually refers to the rate set by Central Banks from which other debt instruments are valued. read more. Rising bond yields can also be damaging for equityEquityThe universe of traded company shares. Investments can fluctuate according to market conditions, the performance of individual companies and that of the broader equity market. read more valuations as future earnings get discounted at a higher rate, thereby lowering present value. Although, we remain optimistic given the types of businesses we invest in, specifically businesses that avoid controversies, are well run and are solving major global challenges and thus underpinning future earnings. EquityEquityThe universe of traded company shares. Investments can fluctuate according to market conditions, the performance of individual companies and that of the broader equity market. read more markets are also being hit by rising supply chain costs, delivery delays and impacts to business in the face of climate and biodiversityBiodiversityRefers to every living thing, including plants, bacteria, animals, and humans. Biodiversity is a term used to describe the enormous variety of life on Earth. read more crises. Against this backdrop we believe, in the current market, alternatives can be an effective diversifier and provide inflation protection across a risk adjusted portfolio.
“Alternatives” are a large asset class, traditionally associated with commodities and real estate. But the fundamental quality we look for at Tribe is diversification from the traditional assetsTraditional assetsTypically implies standard shares and bonds. read more of equities and bonds. Our expectation is that alternatives will be less correlatedCorrelatedA measure of the proximity of performance between different investments. read more to traditional assetsTraditional assetsTypically implies standard shares and bonds. read more. This means they can improve the overall risk and return profile for our clients over the long term as they are intended to reduce overall portfolio volatilityVolatilityA statistical measure of the dispersion of returns for a given investment. This is used by investors as a standard measurement of risk i.e. generally higher volatility is viewed as higher risk. read more. Including different types of assets can improve total returns, as well as deliver yieldYieldA return measure for an investment over a fixed period of time. read more and downside protection. Importantly, alternatives have the ability to create impact returns, often more directly than the equity market. This is especially true of many of the investment trusts we’ve supported the listing of over the past few months as we’re able to provide private capital directly to areas that previously couldn’t access it.
There’s no ‘one size fits all’ approach available in alternatives and within our investible universe there are opportunities across the risk spectrum which can target different returns, liquidities and yields. As well as traditional sectors like real estate (where we focus on sustainabilitySustainabilityMeeting today’s needs without compromising the ability of future generations to meet their needs, by working towards the attainment of the UN SDGs. read more), there are also opportunities within microfinanceMicrofinanceA type of banking which provides financial services to low income individuals or groups of people who would otherwise have no access to finance. read more, battery storageBattery storageThe capturing and storing of green energy that isn’t needed at the time of generation and is saved until it’s needed. read more, carbon, forestryForestryThe practice through which humans create, manage, plant, use, conserve and repair forests, woodlands, and associated resources for human and environmental benefits. read more, emerging market renewables and social housingSocial housingHousing provided for the disadvantaged or with specialised requirements, usually funded by local or central government. read more – to name a few. As an impact investor, alternatives are where we’re starting to see good opportunities to create positive changes to society.
Some alternatives, for example battery storage facilities, woodland or a basket of micro-loans, aren’t subject to short term economic forces. The biological growth from trees and the value of the timber will still happen if US equities fall. If the price of timber isn’t particularly attractive, trees that would have been harvested can be left in the ground. This is a big part of the appeal in alternatives: they can reduce volatility across a portfolio and can act as a buffer when traditional markets are volatile.
Many investors think inflation could cause markets to stutter in 2022. With some alternatives, however, there can be a degree of insulation given the underlying entities. They can also have higher dividends which, crucially, are index-linked (i.e. linked to inflation). Social housing in the UK is one example. Not only is it relatively well protected given local government pays the rent, these payments are also increased in line with inflation, unlike investing in most bonds, where you receive the same amount of money in real terms.
However, like any asset classAsset classA group of investments or securities which have similar financial characteristics such as equities, fixed income, alternatives and cash. read more, being too overweight in alternatives carries its own set of risks. Alternatives can suffer as a result of a sector-specific, idiosyncratic risk. For example, a life sciences business we looked at has struggled during the Covid pandemic as they have been unable to perform new diagnostic tests during lockdowns. Another risk could be damaging technical factors such as divergence of the underlying liquidityLiquidityHow easily an asset or security can be converted to cash. The frequency and amount an asset or security trades without affecting its market price. read more within the vehicles.
In the current environment, alternatives have become an increasingly important asset class for our portfolios given both their financial and impact driven characteristics. We consider them a good diversifier which can complement a broader portfolio with global equity exposure. Alternatives have the ability to offer total return potential, as well as inflation protection and income characteristics, which in the current market are becoming increasingly harder to find. Given the difficult market conditions for equities and fixed incomeFixed incomeAn investment that pays a fixed amount of interest like a bond and typically aims to preserve capital. read more, we believe alternatives offer an opportunity to access yield, reduce overall volatility and have the potential to generate impactful risk-adjusted returnsRisk-adjusted returnsAccounts for the potential return/profit of an investment whilst considering the potential risks and volatility that must be accepted with that investment in order to achieve it. read more.
