At the beginning of every Chinese New Year, AsianInvestor makes 10 predictions about economic, political and financial developments that are likely to have an impact on the way institutional investors assign their money.

Our second question for the Year of the Pig focused on how much Asian asset owners could seek to add to their weightings in illiquid alternative assets, as they hunt for returns in an increasingly uncertain economic environment.  

How much will Asian asset owners increase alternative asset allocations (on average)

Answer: around 10%

In recent years, the appetite of asset owners for alternative investments has only grown – particularly as fixed income returns have waned and equity markets have become less predictable. The rising interest in private equity, private debt, real estate and hedge fund investments looks set to continue, to the point that it is predicted to become a $14 trillion market in global assets under management in 2023, according to alternative data specialist Preqin.

On average, Asian asset owners have engaged less with alternative assets than their European and US peers, but more are becoming willing to venture into these illiquid assets. Taiping Investment Holdings, which is tasked with overseeing up to 25% of China Taiping Insurance’s alternative asset portfolio, is eyeing more private senior secured loans over the coming year. Japan’s Government Pension Investment Fund, the world’s largest retirement fund, intends to allocate some $41 billion into alternatives in the coming few years, while Japan Post Bank aims to pour a further $62 billion into the industry by 2021.

The appeal of alternative assets lies in their steady returns over long periods. Provided investors are willing to sacrifice liquidity over extended periods, they are a decent likelihood of ensuring a level of return that can lie anywhere from the mid-single digits into the teens, depending on the asset class.

Even the private credit space provided more than 3% absolute returns in 2018, an investment consultant told AsianInvestor. That’s not bad given that equity returns were awful and the SP Global Developed Bond Index only returned 1.35% across 2018 as a whole.

As the global economy grapples with uncertainties over geopolitical tensions, using alternative assets to diversify and lock in such returns is likely to only gain in appeal among Asian asset owners. AsianInvestor predicts they will, on average, increase the size of existing alternative asset allocations by about 10% over the coming year (so an asset owner with a 10% allocation would raise it to 11%).

Partly this increase may reflect investors executing existing plans from 2017 and 2018. In addition, many pension funds and insurers are seeing their assets increase, and they will inevitably add more assets into alternatives as they deploy them.

LIQUIDITY CONSIDERATIONS

It is, however, worth considering the effect of many alternative assets’ illiquidity in a more volatile environment.

While alternative assets typically offer a more consistent return on investment, investors cannot easily extract their money in the event they need to. When making a 10-year commitment in a private equity fund, investors give up the chance to buy an asset that is safer and more agile, such as cash.

Shane Oliver, AMP Capital's head of investments, said that investors “would have been okay” if they were cautious on the market and “loaded up on cash” in December, which he said was “the worst pre-Christmas period on record for the US [equity] market”, reported the Australian Financial Review.

Worse, investors are receiving less return than ever for locking their money away for years int0 alternative assets. The current illiquidity premium has hit a 10-year low, according to a dataset from Willis Towers Watson. As a result, investors are expected to deploy their capital at a slower pace, working towards their allocation targets through multi-year investment programmes.

It’s also worth remembering that some alternative assets are more illiquid than others, which can make them riskier and harder to justify incorporating into a portfolio. Although Asian asset owners are expected to continue increasing their overall allocation into alternative assets, the jittery nature of the markets means they are likely to become more selective around real assets such as infrastructure and real estate.

Instead, it’s possible that more capital could flow towards more liquid forms of alternative assets, such as real estate investment trusts or hedge funds. The latter asset class lost 3.42% in 2018 as it finished the year with the lowest return since 2008, noted a Preqin factsheet, but it could potentially tap the current market volatility to outperform a falling market. 

Previous Year of the Pig predictions: 

Will the US economy suffer a major downturn? 

This story has been updated to clarify the amount by which investors will increase their alternative asset allocations, on average.