Facing moderate economic growth, higher inflation, and the prospect of low returns in public markets this year, investors need a new playbook.
That’s the overarching finding of J.P. Morgan Asset Management’s latest alternatives outlook. The next promising investment ideas will likely be in the alternatives space, particularly in hedge funds and real assets “whose income is a function of inflation,” according to Anton Pil, global head of alternatives at JPMAM.
In J.P. Morgan’s 2022 Global Alternatives Outlook, which looks out over the next 12 to 18 months, Pil and his colleagues identified “muted expected returns, historically low interest rates and elevated volatility” as key risk factors for investors in the public market. “Public markets have delivered remarkable performance over the past two years, but we expect that returns will be lower and volatility higher going forward,” according to the report, which was expected to be published Thursday. JPMAM tapped the thinking of the 700-person team in its $200 billion alternative investments group to produce the outlook.
But hedge funds, especially market-neutral funds that use a combination of long and short positions, and derivatives, can generate profits regardless of the market trend. Such funds could help investors expand their investment universe instead of focusing on a marketplace that’s “somewhat directional over a period of time,” Pil told Institutional Investor.
Hedge funds that have adopted relative value credit strategies or macro strategies are likely to be top performers in 2022, Pil said. Instead of evaluating assets separately, funds with relative value strategies would pair highly correlated assets together to find any mis-pricings. The credit market will likely see “a broader dispersion” as rising interest rates put companies under more pressure to refinance. Some macro strategies are also expected to yield “decent returns,” Pil added, especially those that could align their investment strategies with the fundamental macro trends targeted by global central banks.
JPMAM expects strong growth as well as “alpha” opportunities for hedge funds in a broad range of themes, including biotechnology, cybersecurity, and democratizing access to financial services, especially in emerging markets. Hedge funds will also benefit from trading opportunities arising from high stock and factor dispersions. In fact, valuation dispersions are approaching the ranges last seen during the dot-com bubble.
To Pil, one of the beauties of hedge fund management is that the performance of the funds is generally not compared with market benchmarks. Along with their unique ability to take short positions, hedge funds can provide investors with tools that are often not available from traditional managers. “Uncertainty may be the only certainty in 2022, but our hedge fund investors see significant opportunities for alpha creation as markets recalibrate for an ever more unpredictable future,” the report said.
The report stressed that hybrid-like alternatives, which demonstrate both equity-like and fixed income-like characteristics, can “provide public equity diversification, stable returns and the potential for alpha/growth.” Equity-like hybrids include private equity and non-core real assets, while fixed income-like hybrids include subordinated credit and parts of private credit, such as middle market direct lending. Hedge funds and core real assets, on the other hand, overlap with both categories and thus become ideal investments amid rising market volatilities. “Looking ahead, discretionary macro strategies should be well positioned to take advantage of any volatility spikes arising from central bank moves toward policy normalization,” according to the report.
Real assets, including infrastructure, transport, and timber, are “perhaps one of the places we are going to continue to see outsized returns compared to many other asset classes,” Pil said. This is because cash flows associated with real assets often has a degree of “embedded protection” as the increase in bills and payrolls is directly tied to the consumer price index, Pil added. Plus. the rise of e-commerce and the economic recovery from the pandemic are signaling that warehouses and office buildings “are not going away,” adding to the investment value of the asset class.
“We continue to see many investors, both institutional and retail, looking for alternatives that provide them a source of income that has a bit of an inflation hedge embedded in it and where the value of the security doesn’t fall as the Fed raises rates,” Pil said. “And I think that is going to be the main driver of the outsize performance for most real assets in 2022.”