Historically, individual investors interested in generating safe and stable returns looked to the bond market, which performed predictably and provided investors with a comfortable and low-stress retirement. The 21st century, however, brought with it declining interest rates, lower bond yields, and little indication that the investment environment will revert to easier times.
For investors, this shift means they can no longer rely on what has worked in the past. Investors that want to grow their portfolio or draw stable income from it while maintaining a palatable level of risk need to consider other options. To help, innovative investment managers have developed “alternative” investment approaches that investors can integrate into a portfolio strategy.
In this article, we discuss what alternative investments are and provide an overview of alternative asset classes. For more information on the changing investment environment and innovative portfolio management approaches, please read our Portfolio Guide – Beyond Stocks and Bonds.
What are alternative investments?
Alternative investments refer to any investment strategy that does not take a conventional approach to investing in traditional equities or bonds. Each class of alternatives works to address some of the variety of challenges that investors face while providing diversification benefits within a portfolio and return opportunities. Real estate, private infrastructure, and private equity are the most common forms of alternatives. Others, including hedge funds, alternative income sources, and equity investments in emerging economies, are also gaining attention.
Alternative asset classes have been well-researched, their merits and value proven with institutional investors. Alternatives are commonplace in the portfolios of notable and sophisticated institutional pension funds, such as the Canada Pension Plan, the Ontario Teachers Pension Plan, and the British Columbia Investment Management Corporation.
The main barrier to alternative asset classes has been accessibility for individual investors, with minimum investment thresholds often beyond reach and no public exchange for buying and selling assets cost-effectively. With growing demand, some Canadian investment managers have embraced innovation, introducing several alternatives for potential inclusion in the portfolios of their high-net-worth investors.
What are the major types of alternatives?
There are many alternative asset classes. At CC&L Private Capital, our pension-calibre approach can incorporate the following alternative investments.
Real estate provides stable income and return potential. However, individual investors do not commonly use it due to the value of most transactions and the difficulty associated with gaining significant diversification.
At CC&L Private Capital, our real estate investments include over 235 commercial and residential properties across Canada. They give our clients access to a diversified source of portfolio growth and cash flow, with rent escalation clauses in lease agreements hedging inflation. Our real estate investments include office buildings, industrial manufacturing facilities, distribution warehouses, retail centres, and multi-unit residential properties – assets typically outside the reach of most individual investors.
Traditional infrastructure and energy assets are a less familiar option for most individual investors, given the complexity and high cost associated with access to the asset class. Institutional investors, however, have proven the value of infrastructure investments. For investors who do not require access to their capital in the short term, infrastructure can be a lower-risk means of generating stable cash flow and long-term capital growth. Infrastructure investments have the added benefit of acting as a buffer from economic turbulence in an investment portfolio.
At CC&L Private Capital, we use ”finance, build, and maintain contracts” with proven counter-parties to guide our small- and medium-sized traditional infrastructure projects (e.g., roads, rail, hospitals), renewable power generation projects (i.e., hydro, wind, and solar), and energy transmission assets.
Lending to private, middle-market companies is a way for investors to obtain stable interest payments secured by liens against corporate assets. It makes private loans a reasonable fixed income alternative given declining bond yields. While it is not a common asset class in Canada, it is often seen in other markets, such as the USA and Europe. Private loans also contribute to the diversity of a portfolio, providing an uncorrelated source of income.
At CC&L Private Capital, we offer private loans to middle-market Canadian companies, typically in the range of $20 to $60 million.
The use of hedge strategies offers investors enhanced diversification in their portfolios by providing an uncorrelated source of return driven by analyst insights rather than by market-driven factors.
At CC&L Private Capital, we use three distinct hedge strategies in our portfolio—Canadian small-cap equities, a range of Canadian and global bonds, and global equities—in a manner that can decrease a portfolio’s exposure to core bonds.
Providing capital in exchange for equity in private Canadian companies can be an excellent source of potential return for investors when coupled with the oversight of experts.
At CC&L Private Capital, we utilize the team at our Banyan Capital Partners affiliate. Banyan invests in companies with a historical track record of strong operations and consistent cash flow – working with owners and managers to drive efficiencies and spur growth.
Frontier markets are unclassified markets or markets that are not represented well in the emerging markets index, such as Indonesia, the Philippines, Vietnam, Ghana and Kenya. They have large and growing populations and low but increasing income levels. As incomes rise, these countries’ populations are expected to increase consumer spending on goods and services. It should increase the profitability and business maturity of local companies able to meet rising consumer demand – making such companies ripe for investment.
While frontier investments are more volatile than many other alternative asset classes, their potential for generating returns over the long term is significant. At CC&L Private Capital, we believe that adding a modest allocation to frontier markets can help improve the return potential of a portfolio. However, any investments need to be made based on a discussion of the risk and return trade-offs.
Moving beyond traditional investment approaches
It is becoming increasingly difficult for investors to get the portfolio returns they desire using traditional investment methods in the evolving investment environment. By embracing innovative approaches to a portfolio strategy, including the use of alternatives, investors can better position themselves to achieve their financial goals while managing their risks.
Understanding different investment options is challenging, but an experienced investment manager can help.
This article first appeared on the Connor Clark & Lunn Private Capital website, September 10, 2021