Looking for stable, low volatility investments? Then consider buying alternative assets.
With interest rates at all-time lows—and no clear date when they’ll rise—advisors have had to look for new ways to find fixed income-like securities for their clients. One asset class that some people have turned to is alternative investments, which, for most retail investors, means real estate and infrastructure.
Pension funds have been investing in alternative assets for years—they often buy real estate and infrastructure assets directly—but the average investor and advisor have just started looking at these investments.
Last May, RIA Database, a Charlotte, N.C.-based financial industry data provider, surveyed 1,000 advisors and found that 33% of them allocate more than 10% of their client assets to alternatives.
Nearly 80% of surveyed advisors said alternatives are a critical part of asset allocation and added they primarily use these types of investments to increase portfolio diversification and reduce risk.
Ryan Fitzgerald, vice-president and portfolio manager with CI Financial’s Signature Global Asset Management, isn’t surprised that more advisors are seeking out alternative assets. They can provide attractive yields, low equity-market correlation and can reduce overall portfolio risk, he says.
“The traditional asset mix that many financial advisors have employed no longer works because bond yields are so much lower than what anybody thought they would be,” says Fitzgerald. “That’s forcing capital out the risk curve, but the first stop for that money will be whatever looks the most like a bond.”
Buildings, toll roads, airports and more
When most people think about alternatives, they think about commercial and industrial buildings, toll roads, highways, airports, pipelines, utilities and much more.
All of these assets have cash flows that are incredibly stable, says Fitzgerald. A toll road, for instance, collects coins, day after day, uninterrupted for years. An airport will collect fees and taxes as long as planes continue to fly. A commercial property brings in rents—often long-term—and raises rates when a tenant leaves.
“Watching cash flows from a real estate or infrastructure company is like watching paint dry half the time,” says Fitzgerald. “A disastrous year would be cash flow falling by 3%.”
This stability is a big reason why investors like these types of stocks. In a still up-and-down market, finding companies that have stable cash flows is critical.
Low correlation
The correlation between alternatives and equities is low over the long term. A study by the National Association of Real Estate Investments Trusts found that U.S. REITs and the Dow Jones Total Stock Market Index have a 20% correlation over a 60-month period, while other sectors have an 89% correlation to the Dow Jones index over that same time frame.
It’s a similar story with infrastructure. A 2011 Russell Investments report found that between 2001 and 2007, the S&P Global Listed Infrastructure Index had a 0.35 correlation with the Citigroup Global Bond Index, a 0.65 correlation with the FTSE EPRA NAREIT Global Real Estate Index and a 0.75 correlation with the Russell Global Index. (A correlation of 1 means two asset classes move directly in line with one another.)
Advisors need to keep in mind that these alternatives will move in line with equities in the short term, says Fitzgerald.
“If I wake up tomorrow and some macro event causes the stock market to go down, the REITs will surely fall as well,” he says. “But over longer periods of time, REITs themselves should be more correlated to the direction in pricing of the underlying properties.”
Funds and stocks
Unless your client is an ultra high net-worth investor and can buy a commercial building or an airport him or herself, most Canadians will be purchasing REITs, utilities or infrastructure companies, such as Brookfield Asset Management.
REITs are easy to buy individually—there are many of them in Canada and around the world—but infrastructure is a little more difficult, say Fitzgerald. There aren’t many infrastructure companies in Canada, so you have to know where to look.
For instance, Fitzgerald owns Sydney Airport Holdings, an Australian company that has a 50% stake in the Sydney airport. Only savvy investors who are comfortable managing currency and understand global markets will be able to do this on their own, he says.
Over the long term, more advisors and investors will look to alternative assets for diversification and to get better risk-adjusted returns, says Fitzgerald. In today’s market environment, it’s hard to argue with the stability and solid cash flow that many of these companies provide.