Savvy investors will clean up now the 0% party is over

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This year will be one of uncertainty, but changes in economic regime and in the way we live and work are creating opportunities to generate strong returns, says Teena Jilka

Two big themes dominate my thinking about 2024. One is the change in economic regime that comes with normalizing interest rates. This is a shorter-term trend that will play out over the coming year or two as economies and markets adjust to the new norm and gradually find their feet. Alongside that, I’m also thinking about mega-trends that are going to run for decades – the climate transition and technological change.

These themes are throwing up all sorts of opportunities for investors in private markets and other alternative investment strategies, and often not in the obvious places. I think the coming year will be a period when the best active managers are really going to prove their worth. For investors, being guided by their expertise and know-how will make the difference in terms of returns.

Over the past decade and more, financial markets have behaved like a child running wild at a birthday party on a massive sugar high. But now the parents have arrived and the ultra-cheap money has gone – inflation shot up, rates followed, and that has given rise to volatility in financial markets as well as in geopolitics. Everyone can see we’re in a different environment with a lot more uncertainty, but no one can be sure where all the pieces will fall just yet. Bill Gates famously said: “Success today requires the agility and drive to constantly rethink, reinvigorate, react and reinvent.” To me that sums up how we need to approach 2024 – it’s a time to be light on your feet.

In terms of investment opportunities that should benefit from this volatility, I’m interested in certain types of hedge fund. A lot of funds had a tough time while the liquidity party was in full swing, but now that has changed it’s looking like a very interesting year for certain strategies. I’m thinking particularly about low-beta funds and market neutral strategies that balance long and short positions. Macro and relative value approaches, where managers aim to profit from temporary price discrepancies between similar assets, could do well, too. But diversification and manager selection will be critical because the difference in performance between top and bottom-quartile managers is considerable.

Many investors have topped up on closed-end private equity funds with the classic eight-to 12-year lock-ups. A way to continue to allocate to the space, reduce the J-curve in the near term and attain higher transparency on assets is through secondaries and co-investments. Some quality portfolios and single assets have already come on to the secondary market, due not only to an increasing demand for liquidity, but also to the growth in continuation or GP-led funds. These allow GPs to roll over compelling portfolio assets into a new fund rather than forcing a sale at the end of the fund life. Co-investing alongside private equity funds could be a great complement to well-diversified portfolios. Both could also offer advantageous fee structures for investors.

The other opportunity I’m excited about is non-bank corporate lending by private credit funds. Banks are now more risk-averse and Basel III, the next stage of banking regulation, is going to squeeze their lending capacity further.

So I see a golden age for private credit in terms of the range of opportunities investors will be able to access through this route. Not just in corporate lending, but also in asset-backed (commercial and residential real estate) as well as specialty finance. The returns investors can earn on high-quality, senior secured private loans have risen along with government bond yields and now look very attractive. Obviously, you can take more risk and go after higher returns in private credit if you choose, but there are good opportunities that don’t involve moving too far out along the risk spectrum and will complement conventional fixed-income allocations well. But as I stressed before, diversification and manager selection are key. A lot of new private credit funds are launching so it’s important to be selective and work with those that have proven underwriting expertise. Private credit will offer investors a higher return potential and steady, reliable income streams as well as portfolio diversification.

Alongside these opportunities that I see flowing from the change of financial regime, I’ve got my eye on long-term, structural themes that are changing the way we live, work and play.

Obviously, no one can ignore climate change and the energy transition. In Geneva, where I live, several of the bridges over the River Arve were closed recently because heavy rain meant water levels were so high it was too dangerous to cross them. That hasn’t happened for a century. So the urgency of the energy transition is becoming more obvious all the time, meaning more energy-efficient buildings, more renewables and of course more energy storage. The capital requirements are huge and one obvious way to invest is through infrastructure funds, both focused on certain niches and the large generalist funds. GP-led secondary transactions of good-quality assets in infrastructure have also been on the rise. This could be a good way to gain a foothold in this space.

A couple of other routes are worth considering. I’m interested in venture funds that back companies developing new technologies to catalyze the energy transition, and I also think investors should consider commodities and mining companies that are producing the metals and rare earths that will be required for mass-electrification. Miners with strong sustainability credentials will be in demand, I think.

Finally, the other mega-trend is technology, and particularly the widespread adoption of AI. This is likely to play into the energy transition theme as well because AI will be an important accelerator of the transition to a decarbonized energy system. But it will also impact every area of the economy and over time should deliver big productivity gains. There are obvious ways to invest in this trend, such as the giant US technology companies. But infrastructure funds can be an additional way in because of the need for many more data centers to provide the computing power that AI demands. Then there are more venture and private equity-based approaches, where you have managers backing the next generation of companies developing disruptive technologies.

So overall I see 2024 as a year when investors will have to deal with a lot of uncertainty, for sure. But that uncertainty will create opportunities for investors who work with the really savvy managers to generate value.

Teena Jilka is an investment solutions adviser with Mercer, specializing in alternative assets. The views expressed in this article are those of Teena Jilka and do not necessarily reflect the views of Mercer. No action should be taken based on the content of this article without first obtaining professional investment advice specific to your circumstances.

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