The calendar has turned, but the investment landscape still retains vestiges of the past several years’ dominant economic trends — and will for some time to come. It amounts to a new paradigm for the economy with crucial implications for advisers and their clients, and potentially a very attractive backdrop for generating returns, with help from alternative investments, or alts.
As 2025 begins, we believe the economy is experiencing a different kind of landing that defies easy categorization — one in which inflation and monetary policy rates settle but stay structurally higher than they were pre-COVID, with higher economic growth, too.
Considerable cash remains on the sidelines. Many advisers who are confident that the U.S. economy still has room to run believe that they need to put cash to work. Yet, they recognize, too, that public equity market valuations are stretched — indeed, for many investors, overexposure to U.S. equities is perhaps an even bigger risk than sidelined cash. Advisers see, too, that uncertainty about Fed policy and inflation’s direction has sparked public bond market volatility. At the same time, advisers need to address the expectations of clients who have just experienced back-to-back years of 20%-plus returns for the S&P 500.
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This landscape — particularly the persistence of relatively higher interest rates — reinforces what we believe to be private market assets’ well-established diversification and return advantages. But some first steps are advisable before putting an alternatives allocation in place:
- Consider the market’s full range. U.S. private markets provide access to 23 times more* companies than public markets, offering exposure to a broad spectrum of non-traded sectors, such as private equity, private credit, private real estate, real assets such as farmland, infrastructure and more. For many investors, alts should be considered essential portfolio building blocks.
- Assume an appropriate investment horizon. While the short term can provide valuable clues about good entry points for an alts allocation, an investor generally needs to plan on holding the allocation for a minimum of five years in order to fully earn alts’ long-term diversification and return benefits.
- Understand liquidity needs. A rigorous planning exercise that accurately assesses liquidity requirements will give both adviser and client the confidence to add an appropriate allocation to semi-liquid or less-liquid assets.
Some potential investing ideas
Here are some of our leading private markets ideas:
- Private real estate. We see real estate as a potential “comeback kid” in 2025. For several years, the sector has been shunned due to the high-rate environment, which imposed a significant headwind on new construction across property types — and constricted the emergence of new supply. A strengthening economy with somewhat limited real estate supply bodes well for demand, though not necessarily in the central business district office sector; we see better opportunities in sectors such as industrial, medical office and senior living facilities.
- Private credit. The private credit space has exploded in recent years, but it is not a go-anywhere strategy — it demands selectivity. We see appealing opportunities in the higher quality areas of middle market direct lending to private equity-backed companies. Middle market loans may continue offering attractive yields even as base rates decline, representing a consistent and resilient source of cash flow in either a hard or soft landing for the U.S. economy. In our view, attractive all-in yields coupled with a potentially renewed M&A environment in 2025 sets up private credit to be a relative outperformer.
- Farmland investments. Farmland is perhaps the ultimate portfolio diversifier, with inelastic demand for the end product (food) and strong income gains over decades driven by increased productivity in the farmland space. We believe technological progress in farming — a huge factor in the sector’s unique return profile — will continue going forward.
Advisers who believe that their real value lies on the investment side via customized portfolio design — particularly for a younger generation of clients accustomed to personalization in so many aspects of their lives — need to consider alts part of their strategic mix.
They need to recognize, too, that, going forward, dispersion of private market returns may be far greater than for publicly traded assets — making the due diligence offered by a partner with deep multiasset experience an essential prerequisite for building a portfolio under a new economic paradigm.
* Source: Bloomberg, as of 31 Dec 2023. Representative Indexes: U.S. LC Growth (Russell 1000 Growth Index), U.S. LC Value (Russell 1000 Value Index), Non-U.S. Stocks (MSCI ACWI Index), Private Credit (Cliffwater Direct Lending Index), Private RE (NCREIF ODCE Index), Cash (Bloomberg U.S. Treasury Bill 1-3 Months Index), Core Bonds (Bloomberg U.S. Agg Index), HY Bonds (Bloomberg U.S. Corporate High Yield Index), Munis (Bloomberg Municipal Bond Index), Diversified Portfolio (20% U.S. LC Growth, 20% U.S. LC Value, 10% Non-U.S. Stocks, 10% Private Credit, 10% Private RE, 2% Cash, 10% Core Bonds, 4% HY Bonds, 14% Munis). Private as of 30 Sep 2023. Diversification does not assure a profit or protect against loss.
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Investors should be aware that alternative investments are speculative, subject to substantial risks including the risks associated with limited liquidity, the potential use of leverage, potential short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. 4135887-0925
