The global economic outlook this year looks gloomy and more uncertain, at least according to the latest research data by the International Monetary Fund.
Several shocks have so far hit the world economy which had already been weakened by the pandemic: higher-than-expected inflation worldwide triggering tighter financial conditions, especially in the US; a worse-than-anticipated slowdown in China, reflecting Covid- 19 outbreaks and lockdowns; and further negative spillovers from the Russia – Ukraine war.
Back home, the 12-month overall inflation rate reached 8.5 percent in August 2022. The cost of living has gone up, and activities in the private sector hit a 15-month low in July as Purchasing Managers’ Index survey data signalled a decline in new orders and muted business confidence. Yields on government securities have increased significantly in the 9 months to September 2022.
Case in point, five-year bond yields are currently at levels last seen on 15-year papers in December 2021. This has resulted in negative mark to market returns on bond holdings. Globally, equities have suffered from poor corporate earnings due to supply chain disruptions and low valuations as a result of higher discount rates. The electioneering period when volatility among traditional forms of investments such as stocks, bonds and cash increases due to increased perceived risk has also contributed to the poor performance of the Nairobi Securities Exchange, which is down 15.8 percent so far. However, all is not lost, alternative investments do exist.
Risk redistribution
Alternative investments do not fall in the traditional classification as mentioned above. They tend to appear as a better option for investors in redistributing risk. These include tangible asset classes such as precious metals, real estate, and natural resources. They also take the form of financial assets such as private equity, private debt, and hedge funds.
The key attractive feature is their historically low correlation with traditional asset classes, which creates the opportunity for portfolio diversification resulting in a higher risk-adjusted return. Alternative investments tend to be insulated against market volatility such as has been witnessed in global equity markets in the recent past.
For instance, we expect government borrowing to continue soaring, and interest rates to rise as the central bank aims at curbing inflation. We also expect the equity market’s volatility to persist in the short-term as the long-term effects of the Covid-19 pandemic on the economy dissipate slowly. This all creates a challenging investment environment with low equity price movements and limited correlation benefits between fixed income and equities.
Incorporating alternative investments in portfolio construction will provide the necessary diversification and improve risk-adjusted returns, especially in periods of slow economic growth as seen in the last two years.
Supporting markets
The alternative investments industry has become a critical component of the global financial system and world economy. Investors now deploy trillions of dollars around the world, playing a critical role in supporting global capital markets, and redistributing risk.
The alternative investments space continues to evolve as technology-backed investment products such as digital currencies, artificial intelligence, cryptocurrencies and investment vehicles in the decentralised finance ecosystem are gradually gaining interest and trust.
Risk characteristics of alternative investments typically include illiquidity, less regulation, lower transparency, higher fees and limited historical data. They may also have complex legal and tax considerations and investors in alternative investments have to ensure these characteristics fall within their risk capacity.
Ms Vuku is a research analyst at the Old Mutual Investment Group, Kenya.
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