Alternative investments

Where do you see inflation and interest rates going?

So our expectation is that inflation is largely a rear-view mirror problem. In other words, the disinflationary trend is very much in place and we're going to see inflation continue to come down over time. The wheels have been set in motion by this aggressive tightening cycle. Now, having said that, different economies are in different places. The US started tightening early, as did Canada.

So it's in a more mature place in terms of its disinflationary process. But Europe is close behind and clearly the economy has been very, very resilient. But it is following the same trajectory as the US in terms of likely seeing an economic slowdown and, of course, seeing a moderation in inflation. So that gets us to the big question on rates.

And our expectation is that, first of all, the Fed is done. I do believe that what happened in early May, the FOMC meeting and its announcement, while confusing, represented a de facto conditional pause. Now, the Fed has said it wants to keep rates at this high level for a long time. But we could very well see, especially if this disinflationary trend is as strong as I suspect, that the Fed could certainly cut rates by the end of this year. Some kind of a maintenance cut.

As I said, Europe is a little further behind. So what we anticipate is that it's going to take longer to get to the terminal rate, but the terminal rate is going to be significantly lower than the terminal rate on the Fed funds. So we are getting to the end of the global tightening cycle. And I think that's important to recognise.

I think long rates are moving down and, at a certain point, we should see short rates start to follow in any environment. But certainly in an environment of uncertainty, it's important to have a well-diversified portfolio with some asset classes that have lower correlations to the main asset classes, the staples of portfolios like equities, like fixed income. And so I think this is a time in which investors may recognise more the benefits of diversification with alts in a portfolio.

How have alternatives performed over the last year in the face of so much market turbulence?

So if we think about 2022, that was such a difficult period for two major asset classes, equities and fixed income. Investors were disappointed. Many questions were asked on the part of clients about whether or not balanced portfolios make sense.

I think of 2022 as the kind of year in which investors recognised the benefits of alts. Having a diversified portfolio with alternatives exposure. Because they did exhibit a very different performance. They were a lower correlating asset class relative to equities and fixed income, and that was a year in which it really mattered. It helped smooth returns for those investors that did have exposure to alts. And again, to me, that's the kind of year in which investors can look and see the benefits of diversification with alternatives.

Now that interest rates are so much higher, is there still a case for alternatives?

Yes, absolutely. There is a case to be made for alts in any market environment. And I would suspect that, a year from now, the rates environment will be quite different than it is today. The market environment could be very different than it is today. What is enduring is the diversification benefits that investors can get through alts exposure.

So absolutely. Alternatives make sense.

What does a higher interest rate environment mean for real estate?

We have to recognise real estate has historically and still offers high absolute yields. And so I think it's still a very competitive investment option. I do think there's concern that higher rates environment is challenging for commercial real estate, especially since so many loans are anticipated to come due in the next several years. And there's concern they'd have to refinance at a significantly higher rate.

Although I will point out that I think that we could be in a very different rate environment next year and beyond. We're certainly seeing long rates already come down. It's also important to note that if asset classes like real estate come under pressure, that could represent opportunities as opposed to areas of concern. And finally, I think we need to understand that commercial real estate doesn't just apply to office space.

There is this is actually a very broad category that encompasses industrial warehouses, medical office space, dormitories, storage facilities. It's not just about office space. And so, while there are areas that could be challenged because of the environment (let's think about, in a post-pandemic world, less office usage – although I would argue that return to work policies are moving in the right direction for office space), there are other areas where there are some really compelling secular growth opportunities. So this is a time, in my opinion, to not shy away from real estate.

Now that public credit markets are offering higher levels of income, is there still as much of a case for private credit?

I think this is a compelling time for private credit. If you think about the Global Financial Crisis, 2008 to 2009, private credit held up well. It performed well relative to other asset classes. And that's because of the kind of features that it offered, like financial covenants that ensured prepayment that ensured a lot of features that were protective in nature.

And while I am not suggesting we are going into the Global Financial Crisis, absolutely not, I do think the economy is going to get worse before it gets better. And so this is this is a time in which the kind of financial covenants offered by private credit could be could be a very attractive feature for investors.

At Invesco, we also have a broad range of exchange-traded commodity products. How might these come into play, given your outlook?

Well, if you think about our outlook, our expectation in the short term is that we are going to experience significant headwinds that are going to exert pressure on risk assets. And, in that kind of environment, typically defensive positioning has worked. Part of defensive positioning tactically would be an overweight in gold. And so one could easily access that overweighting of gold exposure through ETFs.

Now back to our macro outlook. Our expectation is that those macro headwinds are likely to be relatively short-lived. That, at a certain point, we'll see clear and convincing evidence that that central banks are done tightening and markets will start to discount an economic recovery going forward.

And that would mark a distinct market regime shift to a more risk-on environment. So, for a tactical allocator, that would mean going into their commodities allocation and moving from an overweight to gold to an underweight, while at the same time moving to an overweight in oil, which is a cyclical commodity. One that that's closely tied to the economic cycle.

And so, for investors who are tactical allocators, ETFs and the access they provide to commodities can be very valuable in making those tactical calls.