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Investing the New Way

Where is the Smart Money Investing?

The most sophisticated investors in the world are allocating more of their assets to Alternative Investments due to chronically low bond yields, extreme central bank intervention, and the threat of overheated stock valuations. They believe that Alternative Investments will give them a better chance of achieving sufficiently higher returns to meet future obligations while protecting against excessive downside risk.

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Endowment Funds vs Traditional Portfolio

Composition

Goodbye Traditional 60%/40% Portfolio – High-interest rates during the 80’s and 90’s supported the case of the “balanced” portfolio. Today, volatile equity markets coupled with increasing interest rates and low return bonds have created headwinds for the investment community.

Barrons, JP Morgan, and Bank of America all say your traditional 60/40 retirement portfolio is dead. In fact, JP Morgan says your 60% equity and 40% fixed income portfolio will only be expected to generate 3.2% annually going forward. For the majority of Canadians, 3.2% after inflation and taxes simply will not work!

Hello New Pension Fund Style 60% / 40% Portfolio – At Harbourfront, we believe an asset mix (as shown here) 40% Tactical Equities, 60% Alternatives.

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Allocation and Benefits

Diversification – Different asset classes with different investment/risk profiles results in lower risk when combined in a portfolio.

Low Correlation – With the recent invention of ETF’s we’ve seen a big uptick in Fixed Income & Equity correlation, alternatives have low to zero correlation with equity markets and traditional fixed income options, creating a more efficient portfolio.

Reduced Drawdowns – Uncorrelated assets will perform differently at different times. Alternatives perform more consistently with lower volatility, protecting portfolios from large drawdowns or losses.

Risk-Adjusted Returns – With lower volatility than fixed income and equity, but high-income streams, alternatives provide better risk-adjusted returns.

Investor Satisfaction – Lower volatility, reduced drawdowns, and more consistent income streams create a happier, more satisfied client

Institutions vs Individuals

Figure 4: US Endowment Annualized Performance Over 20 Years

Source: Yale University Financial Report, Princeton Reports of the Treasurer, Harvard University Financial Report, Stanford University Financial Report. * Princeton Alternatives allocation does not include the years 2000-2004 as the financial report did not provide breakdowns of the assets. **The indexes used to mimic the Equity and Fixed Income portfolios are S&P 500 Index and Merrill Lynch Global Corporate Index. Returns are based on June Fiscal Year. Time period: June 1999-June 2019

Private Debt

Private debt also referred to as privately negotiated loans outside of the tier-one financial system, provides investors with senior secured positions in the capital stack making private lending an increasingly attractive option for portfolio diversification because it provides equity-like returns without the volatility.

Who Invests in Private Debt? – Private Lending has been broadly adopted by Institutional investors within Canada. Canada Pension Plan Investment Board (“CPPIB”), Public Sector Pension (“PSP”), and Ontario Teacher’s Pension Plan (“Ontario Teacher’s”) to name a few, have all increased contributions to private debt within their portfolios. Since 2005, the nation’s biggest pension manager CPPIB has increased its private debt allocation from $0-$20.4B as of 2018 (CPP Investment Board, 2018 Breakdown of the Investor Base of Private Lending by Type, source: Preqin Private Debt Online 2018 Annual Report). Other Canadian investment goliaths like the PSP and Ontario Teacher’s followed suit, with PSP increasing its private debt allocation by 15% between March 2018-2019 (Public Sector Pension Investment Board, 2019 Annual Report) and Ontario Teacher’s by almost 5% from 2017-2018 (Ontario Teacher’s Pension Plan, 2018 Annual Report).

Disclaimer: Bond rating may not be available.

Where Does Private Debt Fit?

With many funds offering investors different risk/reward profiles that broadly look attractive relative to traditional fixed income options, private lending funds have increasingly made their mark on institutional and retail portfolios alike.

Being able to provide investors with more SENIOR secured positions in the capital stack has made private lending an increasingly attractive option for portfolio diversification and varying return potential.

With bond yields at historic lows, traditional fixed income will continue to lag behind in the short term. If inflation returns and rates begin to rise this may bring further challenges, thus leaving the fixed income market likely unattractive for the foreseeable future. Of course, that leaves private debt as a viable solution for investors that are looking for security and yield.

Why Private Equity?

For over 20 years, Private Equity investments have outperformed their counterparts in the public market. This is largely due to their ability to better weather turbulent markets and economic downturns. In fact, recessionary environments have acted as catalysts for growth in the private equity landscape due in part to opportunities created. Today, the COVID-19 pandemic has created a capital vacuum providing investment opportunity in this space that hasn’t been seen in over a decade.

The superior performance of private equity investments can also be attributed to an increase in companies choosing to wait longer before going public, ultimately coming to market fully valued. Exponential growth is now occurring in the private stage, offering early investors an exit at elevated public prices. Whether private businesses are grappling with the demands of their growing enterprise or looking to solidify their legacy for the future, the need for investment capital is abundant. As a result, Private Equity has grown to become the single largest Alternative Asset Class globally.

With Private Equity yielding superior investment returns, often with significantly reduced volatility, it is no wonder that institutional investors have been continuously increasing their exposure to this asset class in their portfolios.

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