Confidence in Alternative Asset Classes Amid Uncertainty

In today's macroeconomic landscape, the 60/40 portfolio – historically regarded as a staple investment strategy – is under increased examination. Many investors argue that the 60/40 portfolio may be insufficient to meet the demands of today’s dynamic and unpredictable markets, following two years of relatively poor performance in 2022 and 2023^[1]. Still, others argue that a 60/40 strategy remains relevant, arguing that an expected decline in inflation in 2024 will lead to a more balanced correlation between stocks and bonds^[2].

Against this uncertainty, many investors seeking to diversify risk and fortify their portfolios against volatility are increasing allocations in alternative investments.

The New Wave of Private Credit

Private credit has emerged as an area of interest, bridging lending demand^[3] from private capital markets with investors' hunt for yield. As of March 2023, the private credit market boasted a substantial $1.6 trillion market value^[4], representing about 12% of the $13 trillion dedicated to alternative investments worldwide. Goldman Sachs recently amassed more than $20 billion^[5] to allocate towards private credit investment opportunities.

Private credit has historically exhibited strong returns and has held its value, even during down years; in 2022, the private debt index posted positive returns of 4.2%^[6]. While private equity has shown commendable recovery rates^[7]—with returns outperforming the average by 290 basis points during expansions and 660 points during recessions—the full resilience of private credit under severe economic stress remains untested^[8]. Recent evaluations from Moody’s^[9] have cast a negative outlook on significant players like FS KKR Capital Corp., Oaktree Specialty Lending Corp., and BlackRock TCP Capital Corp, expressing concerns over how these unproven assets might perform in a financial crisis.

Creating Value in Real Estate

The real estate market has been navigating a mix of challenges and opportunities over the past several years, with CRE valuations dropping an average of 42% last year. While office and retail real estate sectors have faced significant headwinds due to the shift towards remote and hybrid work and the rise of e-commerce, the industrial sector has experienced unprecedented growth^[10] over the last two years amid the rapid proliferation of e-commerce and the push for localized supply chains.

Additionally, the heightened investment in biotech and the expansion of pharmaceutical and healthcare industries drew significant growth^[11] in life sciences since 2020. CBRE foresees record construction completions^[12] of 21.3 million sq. ft. in life sciences across the 13 largest U.S. markets in 2024, up from 13.9 million sq. ft. in 2023 and nearly quadruple the amount in 2022. However, a slowdown in venture capital and IPO activity^[13] in 2024 has lowered demand for lab/R&D space with experts warning of oversupply potential in Boston, the San Francisco Bay Area, and San Diego.

A Power Play in Infrastructure

Similarly, infrastructure investments are gaining traction today due to a variety of factors, including government incentives and a recognition of the need to update and expand critical infrastructure. The International Energy Agency (“IEA”) estimates a need for $100 trillion^[14] of new infrastructure investment to reach net-zero carbon dioxide emissions by 2050. This investment requirement has created a sizable market for infrastructure assets, reflected by significant growth in specific sectors such as renewable energy, transportation, and digital infrastructure.

Global renewable energy infrastructure has climbed 50%^[15] from 2022 due to policy expansions and easing macroeconomic hurdles, like inflation and supply chain disruptions. The push towards renewable energy is backed by significant government policies aimed at tripling^[16] global renewable capacity by 2030. In the U.S., over $1.2 trillion^[17] has been allocated between 2021 and 2030 for modernizing the nation's infrastructure, including significant funds for roads, bridges, and major projects.

These developments lend to a strong upward trend in infrastructure investments, driven by the asset class’ historically stable cash flows. In 2022, infrastructure assets delivered a 5% total return^[18].

Farmland Investing: An Emerging Opportunity

The NCREIF Farmland Property Index, which tracks the performance of US farmland, has a proven track record of stability through multiple economic cycles and market downturns over the last several decades^[19]. Even in high-interest rate environments, as is the case today, US farmland values have remained relatively unshaken; cash rents and land values both increased in 2023^[20].

The current debt-to-asset ratio for farmland was 12.73%^[21] in 2023 and is forecast to only slightly increase to 12.78% this year. This modest leverage ratio means that farmland has been less sensitive to the risks associated with rising interest rates. As a result, the rapid rate increases we saw throughout 2023 haven’t wielded as much influence over the financial health of farmland as it has over more heavily leveraged assets.

Instead, farmland’s value is more closely aligned with the asset’s strong, long-term market fundamentals^[22]. The global population is projected to reach nearly 10 billion by 2050, driving substantial increases in demand^[23] for agricultural commodities and farm products. This growth, along with rising incomes and changing diets in developing countries, is leading to higher food consumption globally. Meanwhile, the supply of arable land is shrinking^[24], further enhancing farmland's scarcity value. Against this backdrop, high-quality farmland in major productive regions, such as California’s Central Valley, is positioned to benefit significantly, presenting an opportunity for investors to capitalize on farmland’s strong market fundamentals.

Farmland investments also present opportunities to amplify long-term returns through value-add potential. One avenue for potential appreciation lies in development properties, as these properties offer upside as they undergo development or transition into more profitable uses. Moreover, in distressed markets, farmland can offer a unique opportunity for investors to acquire undervalued assets with the potential for substantial appreciation as market conditions improve.

Building Resilience with Alternatives

As investors seek to navigate economic uncertainty and market volatility, many are considering alternative assets as a compelling component of diversified portfolios, offering the potential to enhance risk-adjusted returns while mitigating exposure to traditional market fluctuations.

Real assets, in particular, have gained traction given their ability to deliver uncorrelated, returns with historically lower volatility^[25]. Several key macroeconomic factors, including anticipated lower inflation and falling interest rates at the end of this year, should continue to support these investments in the near term^[26]. The tailwinds in the life sciences, industrial, and farmland sectors highlight the broader trend toward specialized and essential assets to enhance portfolio resilience.

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