All this changed in 2022 when central banks raised interest rates rapidly to counter unexpected inflation. As a result, fears over slowing growth led to equities and bonds falling in tandem, even though we normally expect one to rise when the other falls (and vice versa).

This positive correlation between bond and equity prices has extended into 2023 and there are multiple reasons as to why they could remain so heading into 2024. Understandably, investors have been asking whether there are better ways to construct a balanced portfolio. In doing so, they are increasingly looking for more diversified sources of growth and income, that can deliver resilience during periods of market stress. One option may be alternative asset classes. That said, the biggest challenge has been that traditionally they also came with long lock-up periods, high costs, and significant minimum-investment requirements.

Thankfully, this is changing.

Democratizing alternatives

Demand for alternative assets from a broader range of investors has led to the creation of new vehicles. These offer investors access to a combination of private (non-listed) and public assets and are often categorized as semi-liquid, as they only offer investors liquidity during specified periods. While this might be suitable for some, there is always a risk that liquidity may not be readily available during more challenging market conditions.

Alternatively, investors can access truly liquid alternatives via channels such as the investment trust market – closed-ended vehicles that are traded daily on major stock exchanges. These are not new, having been around since the 1800s. But over the past two decades, they have evolved to offer exposure to alternative asset classes, including private equity, infrastructure, music royalties, and litigation finance.

Listed vs. unlisted alternatives

In recent years, however, the experience of investors in listed alternative asset classes has diverged from that of investors who invested directly. Private market investors, accessing alternatives through less-liquid structures, have generally experienced remarkably stable valuations, despite broader market volatility. In contrast, the share prices of many listed alternatives have experienced greater volatility despite reasonably stable underlying asset values. With listed securities often trading at steep discounts to their associated assets, we believe there may be hidden value to be uncovered by patient investors.

Let's look at two of the most promising areas:

Private equity

Private equity valuations have yet to see significant markdowns. This has been the case despite fewer transactions, higher borrowing costs for underlying companies, weaker equity markets, and a more challenging economic outlook. Contrast this with listed private equity investment companies for which share prices have seen sharp declines. With the valuations of their underlying assets relatively stable, discounts to asset values are now extreme (Chart 1).

Source: Numis, November 2023.

Infrastructure

Reported infrastructure valuations have been equally resilient. While core infrastructure assets with little inflation linkage have felt some impact from rising interest rates, those assets with a positive inflation linkage, or are underpinned by structural megatrends – such as urbanization – have performed well.

It is a similar story within the renewable energy sector where there is long-term demand from the global commitment to decarbonize energy production. That said, despite resilient performance during the initial impact of inflation and interest rate shock of 2022, many listed infrastructure companies now trade at historically unprecedented discounts (Chart 2).

Source: Numis, November 2023.

What’s the outlook for listed alternatives?

Investors should question the valuations of private market assets and ask whether the discounts associated with listed alternatives represent hidden value, or whether they reflect a likely future deterioration of underlying asset values. The stability of private equity valuations, in contrast to the large swings in equity and bonds markets, has been met with skepticism by public market investors. Similarly, rising bond yields have led to questions regarding the impact on the valuations of infrastructure projects, despite tailwinds such as inflation-linked revenues.

In periods such as the one we’re in, when there is a heightened focus on valuations, we would expect increasing discounts in public markets to emerge, with investors requiring a margin of error on asset valuation assumptions. However, in many areas of the market today, what we see is listed alternative share prices that have dislocated from private market valuations and are factoring in a more pessimistic long-term outcome. That said, we have seen several recent private market transactions which help to validate underlying asset values and highlight the potential for compelling long-term opportunities. This is most apparent in the listed infrastructure space, where we see significant long-term value. There are also more selective opportunities in listed private equity.

Final thoughts

As we enter 2024, we see significant opportunities driven by:

• Differentiated underlying risk and returns from traditional asset classes
• Attractive long-term returns opportunities enhanced by current share price discounts
• The realization of shareholder value through asset sales and other corporate actions

To exploit these opportunities, we believe investors should ignore near-term noise, focus on the underlying fundamentals of investments, and identify quality opportunities with robust, or improving, governance structures.

AA-081223-171830-1