As public markets continue to decline, investors are all trying to answer one burning question: “what do we do with our investments during a recession?” After all, relying on experience isn’t necessarily a competitive advantage here. Strategies that once worked in past recessions are vastly different from those that apply to today’s market, where the list of alternative investment options has grown exponentially.
From investing in real estate and multifamily residential properties to seeking innovation cycles that hone in on “value over volume” strategies, we could argue that investors now have more opportunities than ever to diversify through alternative investments. However, how these alternative investments perform in a market downturn is critical in ensuring the firm can reap the many diversification benefits and returns these types of investments can offer.
To leverage alternative investment strategies as opportunities in a public market downturn, PE/VCs need to pair market history with key correlations in sources of return. Keep reading as we share findings and strategies to help PEs decide whether the market declines are foreshadowing or a unique opportunity to diversify through alternative investments.
Recession-Proof Your Portfolio
The ability to diversify through alternative investments is relatively easy. The challenge lies in understanding how these alternative assets function during times of economic distress. This understanding is crucial to recession-proofing the portfolio. PEs can get a headstart by analyzing top-performing asset classes of market crashes from 2018-2022. While some asset classes, like crypto, experienced dramatic declines in the past few years, others continue to perform well even in rocky markets.
Unlike crypto and stocks, residential real estate took only minor hits, which could indicate a promising future despite a looming recession. Along with residential real estate, gold, whisky, farmland, and wine all saw moderate returns.
Gold came out on top, generating returns of +8.70% in just a few months; fine art (+7.54%) came in at a close second; investment-grade whisky came out third (+5.40%). And, because of their inverse correlation with stocks, bonds (perhaps unsurprisingly) produced decent returns.
Look at Correlations to Drive Differentiated Sources of Return
A market with a history of outperformance exposes investors to two differentiated sources of return: alternative beta factors and alpha sources from manager skill. Alternative beta factors are systematic exposures to risk in areas of a market with low or no correlation. Alpha returns are skill-based, situation-specific, and highly dependent on the skillset of the investment manager. Both can drive returns and have the potential to generate alpha from insight, but contrary to the last major US recession, PEs now have a unique advantage.
With a new set of opportunities to choose from, firms now have a host of tools available to help identify trends and patterns faster and inform strategy earlier in the research phase. In just a few clicks, PEs can gather internal data and combine it with past market history to analyze past performance of specific markets during economic crashes and downturns and forecast their returns more accurately.
Take asset allocation, for example; moving stock investments into cash or bonds was a smart strategy in past decades. However, the problem with publicly traded stocks is that their performance is tightly correlated, meaning they move together. When a publicly traded stock goes up, most all public stocks move in the same positive direction. On the flip side, when one goes down, they’re more than likely all going down.
Another example is hedge funds. Rather than viewing them as a single “illiquidity premium,” their underlying return drivers could help inform portfolio construction for more specific solutions. This custom-tailored approach might be the differentiated edge a firm needs to outperform the competition while taking advantage of a value-add opportunity from the start.
Be the First to Identify Alternative Investment Opportunities
With so much information available at your fingertips, it can be challenging to weed through all the noise. To help identify unique opportunities through alternative investments, especially while navigating an economic downturn, Altvia is here to help.
Subscribe to the Altvia newsletter to get the latest news, trends, and insights delivered straight to your inbox, then start a conversation with our team to learn more about how our PE-specific software can help throughout each step of alternative investment strategy.