A Volatile Market: An Interesting Outlook for Alternative Investments

By QP Wealth Management

A Volatile Market: An Interesting Outlook for Alternative Investments

By Whitney Struble, Director of Client Services, QP Wealth Managment

May 29, 2020

We founded QP Wealth Management just over a year ago with exceptional partners, a passionate foundation, and a belief in utilizing some commonly untapped resources. “QP” stands for qualified purchaser; a person who meets certain financial criteria that qualifies them to participate in alternative investments. The type of investments that you can access largely depends on whether you are an Accredited Investor (AI), Qualified Client (QC), or Qualified Purchaser (QP). And it’s the use of these alternative investments that sets us apart from the vast majority of wealth managers. We have been utilizing alternative investments to complement the main body of high net worth individuals’ and entities’ investment portfolios for the past twenty years. Over this time, we’ve found that many of these QPers (despite their qualified status) lack exposure to alternative investments.

When an investor decides their asset allocation the solution is dependent upon what return expectations they have and how much risk they are willing to tolerate. This is particularly relative given the current ambiguity of market forecasts. But what if an asset class offered investors the ability to increase returns, reduce volatility, or even both?

One of our favorite research pieces is an annual report published by Morgan Stanley’s GIC (Global Investment Committee) aptly titled the Annual Update of GIC Capital Market Assumptions. In this piece, Morgan Stanley’s GIC forecasts return and volatility estimates for various asset classes over the strategic (7 year) and secular (20 year) horizon. They release this report each April which proved very fortunate given the culmination of recent events. Any forecast released earlier in the year is essentially useless if it disregards the pandemic. So, with their timing right on the money, Morgan Stanley’s projections are very interesting.

We have condensed their assumption into what this means for traditional investment classes versus alternative investments (which we think is the interesting bit).

  • Stocks – Over the next seven years, they see Global equity returns at 6% with annualized volatility at 14.2. To do the math for you, their forecast predicts the potential for equities to suffer a loss of -22%.
    • The bad news is that the U.S. is expecting lower returns and higher volatility than the global. Most investors focus on U.S. Large Cap stocks.  Morgan Stanley expects that, over the same time period, U.S. Large Cap Growth will only grow by 4.8% with annualized volatility of 14.8.  The math translates into downside risk of negative 25%.  How about U.S. Large Cap Value?  Even worse.  They expect 3.6% annualized return with 16.0 annualized volatility.  That works out to nearly negative 28%.
  • Bonds- Here is where traditional investors go to protect themselves. However, if Morgan Stanley is right, you might not get much help.  If we look at their predictions for U.S. Taxable Fixed Income, again, over the next seven years, they expect an average return of 1.5% with annualized volatility of 5.3.  That translates into nearly negative 9%.

That brings us to their assumptions for the following alternative investment asset classes:

  • Equity Return Assets – 4.4% annualized return with 9.4 annualized volatility. That would be roughly the return of a combination of U.S. Large Cap Growth and Value and downside volatility of about negative 14%, or half to two-thirds the volatility.
  • Private Real Estate – 8.5% annualized return with 8.4 annualized volatility. Therefore, a significantly better return than equities with downside volatility of negative 8.3%.
  • Private Equity – 9% annualized return with 12.2 annualized volatility. If they are correct, that again means significantly better return than U.S. Large Cap with lower volatility.
  • Private Credit – 7.2% annualized return with 7.3 annualized volatility. Relative to U.S. Fixed Income that is a significantly better return estimate with slightly less volatility.

 

If you follow the above assumptions you could make the argument that alternative investments are a viable way to mitigate your risk and maximize your potential for return, even in a rather challenging landscape. Bear in mind, these investments are not appropriate for everyone. Factors like illiquidity, large minimums, etc. are why participation is limited to investors deemed qualified or accredited.

We have utilized alternative investments for more than 20 years, which is important to note since it spans several market cycles. In that time, we’ve experienced recessions and corrections, and we believe the current environment creates a particularly intriguing case for alternatives.

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QP Wealth Management is an investment advisor. Information presented is for educational purposes only. Past performance is not indicative of future performance.  Principal value and investment return will fluctuate.  There are no implied guarantees or assurances that the target returns will be achieved or objectives will be met.  Future returns may differ significantly from past returns due to many different factors.  Investments involve risk and the possibility of loss of principal.  The information used in this report were obtained from sources Morgan Stanley.  Please let us know if you have any questions.