For decades, the world’s public financial markets served as the primary conduit between investors and companies seeking significant capital via stock and bond offerings.
Yet with interest rates lingering at anemic levels for years and a shrinking universe of publicly traded stocks, alternative assets have emerged as a viable asset class. Investments in areas such as private equity, private debt, and infrastructure deals are projected to reach $14 trillion by 2023, according to The Future of Alternatives by data provider Preqin. This growth would represent a 59% increase over 2017 levels.
Preqin notes that environmental, social, and governance (ESG) issues are expected to similarly rise in prominence, with 41% of alternative fund managers saying they will use ESG analysis in all of their investments by 2023.
A Higher Risk-Reward Bar
Investors in alternative assets tend to be more sophisticated investors who understand the intricacies of alternative investments. These investments feature sophisticated, nontraditional investment strategies or private deals not subject to the same regulations as public markets. Alternative investments are frequently controlled by a few lead investors or tight-knit management teams. Additionally, alternative assets—which encompass hedge funds, infrastructure, real estate, commodity, and private equity investments—have typically held low correlation to broader market returns.
In exchange for risks including reduced transparency and potentially lower liquidity, many alternative investment managers seek returns that meet or exceed the performance of publicly held stocks and bonds. Because these investments are often structured as private funds, they are limited to accredited and qualified investors.
That said, Pensions & Investments reports that the US Securities and Exchange Commission is proposing to revise its accreditation criteria, making it easier for individual investors to access private funds. While some welcome the push as a way of expanding investment opportunities for “Main Street” investors, others worry that it exposes those investors to dangerous levels of risk.
ESG and Alternative Assets
As part of their extensive due diligence and risk assessment processes, many alternative investment managers have found ESG analysis valuable. For example, among a selection of private equity managers that are Principles for Responsible Investment (PRI) signatories, 47% measured ESG performance and impact within portfolio companies in 2018, up from 25% in 2015.
Looking ahead, the Preqin report found that more than 80% of investors and fund managers in infrastructure and private equity funds believe the importance of ESG will rise further by 2023. Although investors and fund managers in the private debt and real estate spaces are similarly aligned, they diverge somewhat in natural resources and venture capital funds, where investors are more likely than fund managers to see the rising significance of ESG. Meanwhile, there is a wide disparity in hedge funds, where 65% of investors expect ESG to become more important but just 37% of fund managers agree.
As the likelihood grows that more investors could intregate ESG factors in the near future, fund managers who embrace ESG integration could provide a measure of comfort in the alternative asset class.