This changed in 2022. Central banks rapidly raised rates to counter high inflation. Fears over slowing growth led to equities and bonds falling in tandem, despite typical expectations that bonds help counter equity market volatility.
Understandably, investors are asking for better ways to construct resilient portfolios. Specifically, portfolios that might generate attractive long-term returns while providing resilience during periods of market or economic upheaval. We think diversifying across a broad range of assets makes for more flexible and robust portfolios.
At abrdn, we look for fundamentally attractive long-term investments with differentiated risk and return drivers, including traditional and alternative asset classes. We believe this helps reduce volatility in the short term and lessens the reliance on any one asset class to deliver income and returns. Over the past 10 years, we’ve seen significant growth in the breadth and depth of alternative opportunities available in daily traded, liquid forms. These assets potentially offer diversification benefits for portfolios.
While we see selective opportunities in traditional asset classes, we remain cautious about relying on them alone to generate income and growth. Instead, we see several long-term opportunities in a broader range of asset classes with attractive risk and return characteristics across market environments.
How does this look in practice?
- Infrastructure assets: benefit from long-term stable cashflows that are often inflation-linked with capital growth potential. We believe current valuations are compelling on a long-term basis and have the potential to generate strong risk-adjusted returns.
- Local currency emerging market bonds (EMD): potentially delivering attractive returns and diversification benefits.
- Floating-rate asset-backed securities: offering a materially higher credit spread versus similarly rated corporate credit. They also provide structural protection from defaults over time.
- A variety of special opportunities or assets with often idiosyncratic return drivers: these include, debt backed by healthcare royalties or precious metals royalties, which benefit from rising gold prices. Then there’s litigation finance, where performance is based on the merits of a legal case rather than GDP or inflation.
Listed infrastructure: a deeper dive
Listed infrastructure investments are typically valued relative to their net asset value (NAV). Over the past decade, they have mostly traded at small premiums to their NAVs. This reflects the market perception that the outlook has been more favourable for NAV returns and greater marginal demand for them as investments.
In recent years, however, elevated inflation, rising interest rates, and falling energy prices (in the case of renewables) have weighed on share prices, despite underlying NAVs remaining relatively stable. As such, many of these opportunities now trade at significant discounts to NAV. These discounts also potentially reflect more attractive yields available from cash and fixed income, as well as concerns that prospective NAVs could decline.
A buying opportunity
We don’t expect these discounts to NAV to persist in the medium term for several reasons. Firstly, transactional evidence from many infrastructure investment companies at or above holding values is helping to validate NAVs for a range of infrastructure investments.
Secondly, corporate activity is increasing, reflecting current discounts to NAV. We’ve been encouraging companies to reduce leverage, dispose of assets, and buy back shares when at discounts to NAV. Positively, more companies have introduced asset recycling programmes and initiated share buybacks. We believe these measures are value-accretive for long-term shareholders.
Lastly, based on our five-year expected return framework, we forecast these assets will trade broadly in line with NAV by the end of the period. Buying at today’s discounts therefore enhances the underlying expected returns from the assets. Our latest long-term return estimates also highlight how attractive we believe the expected return potential is from these assets compared with traditional assets.
Final thoughts…
In today’s volatile world, investors seek portfolios that generate attractive long-term returns while providing resilience during market or economic stress. We believe the solution is to invest across alternative assets, including listed infrastructure, local currency EMD, floating-rate asset-backed securities and special opportunities. By embracing a diversified approach, investors can better navigate the complexities of today's market environment and achieve their financial goals.