Embrace alternative investments to weather economic storms

Several shocks have so far hit the world economy

In Summary
  • Globally, equities have suffered from poor corporate earnings due to supply chain disruptions
  • However, all is not lost, alternative investments do exist.
An investor looks at the digital board at the Nairobi Stock Exchange(NSE)/FILE
An investor looks at the digital board at the Nairobi Stock Exchange(NSE)/FILE

The global economic outlook this year looks gloomy and more uncertain, at least according to the latest research data by the International Monetary Fund on the global economic outlook.

Several shocks have so far hit the world economy which had already been weakened by the pandemic:higher-than-expected inflation worldwide triggering tighter financial conditions, especially in the US; a worse-than-anticipated slowdown in China, reflecting Covid- 19 outbreaks and lockdowns; and further negative spillovers from the Russia – Ukraine war.

Last month, the 12-month overall inflation rate reached 8.5 per cent.

The cost of living has gone up, and activities in the private sector have hit a 15-month last month July as PMI survey data signaled a decline in new orders and muted business confidence among other economic shockers not limited to the Russian Ukraine war.

Yields on government securities have increased significantly in the nine months to September 2022.

Case in point, five-year bond yields are currently at levels last seen on 15-year papers in December 2021.

This has resulted in negative mark-to-market returns on bond holdings.

Globally, equities have suffered from poor corporate earnings due to supply chain disruptions and low valuations as a result of higher discount rates.

The electioneering period where traditional forms of investments such as stocks, bonds, and cash are increased volatility due to increased perceived risk has also contributed to the poor performance of the NSE, which is down 15.8 per cent so far.

However, all is not lost, alternative investments do exist.

Risk redistribution alternative investments are investments that do not fall in the traditional classification of investment as mentioned above.

They tend to appear as a better option for investors in redistributing risk. These include tangible asset classes such as precious metals, real estate and natural resources.

They also take the form of financial assets such as private equity, private debt and hedge funds.

The key attractive feature of alternative investments is their historically low correlation with traditional asset classes, which creates the opportunity for portfolio diversification resulting in a higher risk-adjusted return for the portfolio.

Alternative investments tend to be insulated against market volatility such as has been witnessed in global equity markets in the recent past.

For Instance, we expect government borrowing to continue soaring, and interest rates to rise as the CBK aims at curbing inflation.

We also expect the equity market’s volatility to persist in the short term as the long-term effects of the Covid-19 pandemic on the economy dissipate slowly.

This all creates a challenging investment environment with low equity price movements and limited correlation benefits between fixed income and equities.

Incorporating alternative investments in portfolio construction will provide the necessary diversification and improve risk-adjusted returns, especially in periods of slow economic growth as seen in the last two years.

It will also contribute to economic and technological advancement within the country.

Alternative investments also allow access to investments in sectors such as health, sustainable energy,education, and consumer/retail which create positive socio-economic impact through increased incomes and jobs, access to basic services and sustainable finance.

They enable investors to actively participate in growth sectors of the real economy while also enjoying risk diversification benefits from traditional asset classes. Supporting Markets.

Also known as non-traditional assets, alternative investments further offer investment options that support investors’ beliefs through an emphasis on Environmental, Social and Governance (ESG) factors.

This allows for non-financial factors to be considered when shaping portfolios in addition to the adaptation of a more sustainable approach to investments.

The alternative investments industry has become a critical component of the global financial system and world economy.

Investors in alternatives now deploy trillions of dollars around the world, playing a critical role in supporting global capital markets, and redistributing risk.

Countries around the world have enjoyed the contribution of alternative investments to economic growth.

China, for instance, has experienced tremendous growth since the economic reforms and trade liberalization were enforced in 1979.

This allowed for foreign direct investment, which to a large extent included private equity firms that have invested heavily in technological advancement and manufacturing.

The alternative investments space continues to evolve as technology-backed investment products such as digital currencies, artificial intelligence, cryptocurrencies and investment vehicles in the decentralised finance ecosystem (DeFi) are gradually gaining interest and trust.

Risk characteristics of alternative investments typically include illiquidity, less regulation, lower transparency, higher fees and limited historical data.

They may also have complex legal and tax considerations and investors in alternative investments have to ensure these characteristics fall within their risk capacity.

The writer is a research analyst at the Old Mutual Investment Group, Kenya.

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