• Alternative Investments

Alternative Investments: Mitigating Volatility After the Coronavirus and Oil Market Shocks

As the markets experience their most volatility since 2008, many advisors are inundated with clients looking for advice. One of the most attractive aspects of investing in alternative investment strategies is their low correlation to the financial markets. As a result, investors need not panic or react to the noise of the stock market, but rather they are able to stay disciplined through their advisor’s guidance by adhering to a well-developed investment plan. Clients never realize their true risk tolerance until they’re forced to stomach such swift market declines as what we are currently experiencing from the COVID-19 outbreak and the oil supply shock.

Many economists are predicting a sharp economic bounce back once the virus is contained. While the economic ramifications will be dramatic and real in the first half of 2020, the ability for a significant economic rebound is present. Right now, the markets are trying to process a supply shock in the form of a production shutdown in China along with the flooding of oil into the market from Saudi Arabia. In addition, demand suffers due to the economic ramifications of the attack on the US shale industry and people afraid to leave their homes while the virus fears run rampant. While this news is especially difficult to process, the reality is that these are all short-term hits to the system that will eventually spur some needed inflationary juice into the global economy.

Companies will diversify their supply chains and they won’t be as reliant on one region. In addition, Saudi Arabia cannot maintain their economy long term at continued depressed oil prices. Eventually, they will be forced to decrease supply accordingly.

In the interim, however, the market volatility has been difficult to absorb. A prudent allocation to alternative investments can help mitigate this volatility. While broader correlations exist to asset classes such as private equity, the lack of daily price marks helps to buffer the noise that develops in public market trading. In addition, an allocation to an area such as catastrophe property reinsurance has proven to have zero (or near zero) to negative correlation on the equity and fixed income markets. As advisors have become concerned with public market valuations over the past few years, we’ve been advocating for at least some reinsurance exposure for proper diversification. Institutional investors have taken note as premiums have been increasing. Finally, areas such as private real estate continue to offer excellent income streams and public market diversification. While the real estate markets have continued to rise, the historic interest rate environment continues to lift the market. Spreads between real estate cap rates and interest rates remain very attractive.

The last week and a half have been sobering for the markets, as the bull market officially ended with the 20% decline from the peak that was reached only earlier this year. Accordingly, we are still trying to process the ramification of the virus spread in the US after the drastic steps taken in China and Italy. That in combination with an oil supply shock, has rocked the markets. In such times, it’s important to stay disciplined to a client’s investment policy. Alternative investments act as a needed diversifier in such policies. Maintaining a necessary allocation even while the public markets are rising can prove to be a welcome stabilizer in times of market stress.

For more information on reinsurance and other alternative investment strategies, please contact me.

Frank Burke, CFA, CAIA, Chief Investment Officer, PPB Capital Partners, 484.278.4017 Ext. 108