A growing array of asset classes is coming onstream - offering new ways to target return and reduce portfolio risk.
The investment universe is expanding. Asset classes once considered highly niche and specialist are seeing a sharp rise in interest as investors from pension funds to wealth managers look for new ways to achieve the yield they need in an ultra low-rate world.
Renewable infrastructure, insurance-linked securities and global loans, among others, are becoming more accessible, supported by improved governance and regulation, more competitive fees and greater investor familiarisation.
Plus new investment classes continue to emerge and grow. From healthcare royalties to peer-to-peer lending to social infrastructure, each has its own source of potential return, risk profile and performance drivers – allowing investors to achieve better diversification throughout the economic cycle.
Judging the universe on its merits
With bond yields already at historic lows and as equity volatility increases, we believe that diversification across these and other non-traditional asset classes is key to generating long-term performance and decent income, while keeping risk and volatility at acceptable levels.
How new asset classes compare on risk and return
The investment ‘sweet spot’ is the top left-hand quadrant of this graph, where asset classes with the highest expected returns and the lowest volatility can be found.
Source: Aberdeen Asset Managers, August 16. Expected return is not an indication of future results. Returns are GBP hedged other than Emerging Market Debt Local.
But diversification should never be undertaken for diversification’s sake. Asset classes have to be judged on their merits and their risks fully understood. Here are three asset classes considered in our multi-asset strategies for their long-term return potential – and their low correlation with mainstream assets.
1. Renewable infrastructure funds
Renewable power sources such as wind, solar, tidal and geothermal are becoming central to global energy policy as climate change concerns force a move away from carbon-based energy. With governments struggling to provide the necessary financing, private capital in the form of closed-end listed funds have become critical to funding, building and managing projects.
Why we think they are good diversifiers:
• Relatively stable cashflows are supported by long-term contracts with utilities and energy providers, alongside additional government subsidies
• Returns are not generally affected by economic conditions and have low correlation to economically-sensitive assets like equities
• By holding funds with fully operational assets we avoid the risks associated with project design and development.
Potential return: Renewable infrastructure funds aim for annual returns of 7-9% and can offer dividend yields of 6%. The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
2. Peer-to-peer lending
As higher capital requirements have forced traditional banks to pare back their lending activities, so peer-to-peer lending has stepped in. Using online platforms, peer-to-peer lending companies match potential lenders with borrowers and make their money by charging an arrangement fee. With borrowers classified by creditworthiness, investors can decide on their preferred level of risk and potential return.
Why we think it is a good diversifier:
• Maturing industry that is becoming increasingly transparent – and benefiting from fundamental shifts in global banking
• Range of potential fund investments that can provide effective access to a diversified portfolio of loans
• Modest loss rates – and the typically short duration of loans – means interest rates can be adjusted if credit conditions deteriorate
Potential return: Peer-to-peer lending funds are typically targeting a total return of 8-9%pa. The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
3. Insurance-linked securities
Insurance-linked securities (sometimes known as catastrophe bonds) transfer some of the financial risks of natural catastrophes from insurers to investors. A term contract is issued and if no natural disasters or other specified events occur during the term, investors receive back their capital. In the interim, insurance-linked securities typically provide an attractive yield to compensate for the risk of the investment.
Why we think they are good diversifiers:
• No economic exposure and so is uncorrelated to equities and other asset classes
• Performance determined by investor’s ability to appraise risks and determine level of exposure to them
• Can be diversified across potential disasters to mitigate impact of any one extreme event
Potential return: Insurance-linked securities are priced relative to the probability of loss that they are covering. We believe that there are some attractive opportunities being priced to deliver an expected return of 7% p.a. net of fees and expected losses. The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
Doing your research
An expanding investment universe presents plenty of compelling opportunity and investment ideas. But identifying which asset classes offer reliable long-term potential at acceptable levels of risk takes experience, good judgement and extensive resources.
We believe investment is best approached through a proven and global investment manager like Aberdeen which has deep research capabilities but can also offer these developing asset classes as part of a highly-diversified and actively-managed multi-asset portfolio.
So if your investment strategy is still focused on traditional equities, bonds, property and cash, you might want to think about taking a wider view.