High-quality fixed income provides you with protection, but no income. Risk assets increasingly provide you with income and growth, but no protection. In a world where real yields are negative, and taking on equity beta is the only way to generate income, adding alternative to a portfolio is emerging as a way of solving for diversification, income and growth.
In real estate, the COVID-19 induced downturn likely accelerates trends that were already in place before the virus began to spread. This means that headwinds to retail properties have strengthened, tailwinds for industrial properties have been reaffirmed and the office sector will remain in a state of flux. That said, we still see value in direct real estate as a source of income, and more broadly, as a portfolio diversifier. On the public side of real estate, REITs provide exposure to more forward-looking sectors like data centers, and simultaneously allow for a more liquid access point to the asset class.
Turning to infrastructure, assets that exhibit less sensitivity to the business cycle are looking increasingly attractive, as much of the prior expansion saw investors chase highly cyclical assets in an effort to obtain private equity-like returns. At the current juncture, however, a focus on regulated utilities and contracted assets, where cash flow is the more significant driver of returns, seems prudent.
Private equity funds may not struggle the same way they did coming out of the financial crisis. With financing much more readily available through a number of different channels, general partners (GPs) may be better able to take advantage of depressed valuations. Deal activity will slow, but gradually rebound as the outlook stabilises, and preferences for technology, health care and anything tied to e-commerce will be reinforced.
Private credit has long been an area of concern. Funds that are In the process of returning capital will take a hit, as a significant share of direct lending is comprised of COVID-19 exposed sectors. There is an evolving opportunity for distressed managers, as well as direct lenders that can provide financing for companies that may be unable or unwilling to tap into Fed facilities. That said, caution is still warranted given uncertainty around the duration of this downturn.
In sum, FK Group should look to core real assets for uncorrelated sources of income, private equity for growth and idiosyncratic opportunities in private credit. As always, however, manager selection will remain of the utmost importance.