Alternatives have had a tough couple of years since 2022 when interest rates moved higher and investor capital was reallocated towards the bond market. But, Newton’s, Paul Flood is optimistic and anticipates alternatives playing a larger role in multi-asset portfolios.

Stable interest rates

Reflecting on recent years, Flood says investors have reduced exposure to some real asset areas. This is mainly because higher interest rates led capital to the bond market, where yields moved from virtually zero up to around 4% to 5%.

However, Flood sees interest rates remaining more stable and perhaps even declining. He believes this environment should be a tailwind for some of the real assets that are bond-like in nature.

M&A and cost disclosure

Elsewhere, Flood notes an uptick in M&A activity in the space. Last year Hipgnosis Songs Fund was bought at a premium to the prevailing share price¹. In February this year, BBGI Global Infrastructure was taken over², and Harmony Energy is also set to conclude its sale³.

Another driver for alternatives is that fact that cost disclosure for investment trusts, under the EU’s Packaged Retail and Insurance-based Investment Products regulation (PRIIPs), appears to be coming towards an end. In September 2024 the Financial Conduct Authority lifted cost disclosure requirement on investment trusts, freeing them from disclosing the fees paid to investment managers on factsheets. Flood says under the PRIIPs regime as it was, some investors moved away from the alternatives market due to the pull-through of costs into underlying costs for end clients, with capital being diverted toward fund structures instead. But that could change with the measures disappearing, he adds.

Another tailwind, Flood notes, is many pension funds have moved from deficit to surplus and therefore been de-risking their portfolios. This has involved selling some of those real assets that had the characteristics aligned with what they were trying to achieve and that they had fixed inflation linked revenue streams.

Discounts

Looking ahead, Flood sees opportunities given the discounts to net asset value inherent in certain investment trusts. He observes, as interest rates rose, the average discount rate also increased. “We now see discount rates around 20-30% below net asset value,” he adds. “We see that as an attractive proposition if those net asset values hold up.” (see chart below).

Flood also believes alternatives have characteristics that can help boost portfolio resilience, namely “stable, regulated revenues with inflation linkage”.

“When bond yields rise because inflation is picking up, these assets tend to do quite well, like we saw in 2022 when real assets performed well at a time when both bonds and equities sold off,” he adds.

Additionally, Flood sees attractive forward-looking returns from investment trusts in the renewables space, particularly on a steady state returns (SSR) basis. SSR is a measure that aims to capture the expected return from investing at the current share price, having adjusted for discount rates, gearing, ongoing charges, inflation assumption and discount/premium to NAV.

The chart below shows the renewable infrastructure space (dark blue line) is showing a spread above the risk free that shows those steady state returns coming up towards 8/9%, ahead of bond yields. 
 

“We think that's an attractive proposition, both from a returns perspective and from a diversification and portfolio construction standpoint. This is one of the reasons we continue to hold these assets in our portfolios and have been adding to this space over the last six to 12 months,” Flood concludes.

The value of investments can fall. Investors may not get back the amount invested.