Beware alternative investments that lean on leverage, says JPMorgan

The firm is warning investors to consider more resilient assets given the late economic cycle

Beware alternative investments that lean on leverage, says JPMorgan

Investors should be wary of alternative asset strategies that use leverage as the high volatility in the markets is likely to persist.

In a new global alternatives outlook report, JPMorgan Chase & Co. is predicting that volatility will remain elevated as the Federal Reserve reverses the unprecedented monetary policy enacted after the 2008 global financial crisis, reported Institutional Investor. “It is naïve to think that quantitative tightening will not impact asset prices around the world — what goes up must eventually come down,” the firm said.

With that view, the firm recommended an overweight allocation to core alternative investments with little to no leverage. Given the risks of refinancing this late in the economic cycle, it said, investors willing to reach for yield in private equity should seek managers that rely less on debt financing to produce returns.

“We’re much, much more cautious today on using leverage,” Anton Pil, a managing partner of J.P. Morgan Asset Management’s global alternatives group, told Institutional Investor. He maintained that investors in alternative strategies —including private equity, private credit, real assets, and hedge funds — should accept lower returns rather than attempt to chase a performance benchmark using leverage.

The report suggested an alternatives portfolio with a 70% allocation to core investments such as real assets and private credit as well as “complements” like hedge funds. The balance can be invested in riskier assets, including private equity and distressed credit, to help boost gains.

Pil said he’s now favouring assets like real estate, infrastructure, and transportation, which the report said can provide stable income and uncorrelated returns that tend to rise with inflation. As the Fed removes liquidity from the market, he views the overuse of leverage as potentially riskier today compared to five or 10 years ago; private credit funds that borrow against their portfolios create another layer of refinancing risk.

“That, I would be even more cautious about,” he said.

Pil noted hedge funds’ general struggle to achieve alpha over the last three to five years, adding that excessive volatility and a broad, drastic market selloff will probably spell continued underperformance for them. Still, he noted, managers focused on relative value generally benefit during periods when market uncertainty occurs alongside a steady-as-she-goes economy.

“That’s actually a goldilocks environment for hedge funds to do well,” he said. “Stars are aligning for alternatives.”


Follow WP on Facebook, LinkedIn and Twitter