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Are alts a substitute for bonds as an income source?

Real estate and infrastructure reduce correlation risk, but be cautious of direct lending products that attract with high yields, argues JP Morgan Asset Management.
Shawn Khazzam, JP Morgan Asset Management

Negative yielding debt makes up about 25% of the global bond market and investors have become more concerned about finding sources of income, according to Shawn Khazzam, Hong Kong-based head of alternative solutions group for Asia-Pacific at JP Morgan Asset Management.

“A large portion of global sovereign bonds in the world are delivering negative yields, and the gut reaction of many investors to achieve their income goals is to top-up slightly in emerging market debt and high yield bonds,” he told FSA in a recent interview.

However, while yields in the emerging markets and high yield space are attractive, investors may not be aware that they are taking on added risks in their portfolios.

“You are taking on added risk, which is higher volatility and higher correlation to equity markets,” he said.

Khazzam believes that investors should consider alternatives as an income source, particularly what he calls “core alternatives”, which include real estate and infrastructure in OECD countries.

Source: JP Morgan Asset Management. As of 30 November 2019.

Yields in core real estate are around 4-5%, according to Khazzam. While their yields are lower than US high yield bonds, they are negatively correlated to the global equity and bond markets.

Source: JP Morgan Asset Management. As of 30 November 2019. Red – positively correlated. Green – negatively correlated

Khazzam added that core real estate has been “tried and tested”, in which investors rely on the leases that should provide them with relatively reliable income.

“The nice thing is having sticky levels of income, because what is driving those income levels are long-term contracts, and that could provide ballast to a portfolio as markets fluctuate,” he said.

In total, JP Morgan AM manages around $150bn in alternative assets, in which a majority of it is in core real estate, according to Khazzam.

The riskier space

Meanwhile, other areas in the alternatives space can yield around 7%-10%, such as private debt.

“Income levels continue to be high in that space,” Khazzam said.

However, investors should be prudent in terms of the companies they invest in and should understand their debt structure.

“The discussion about covenant-lite in the corporate lending space has been a big topic, so investors should ensure that they are getting the right level of protection.”

Covenant-lite loans have grown. According to a report from Bain Capital, the share of covenant-lite loans in the US loan market grew to around 80% as of the end of February last year, which compares to just nearly 20% in 2009.

% share of covenant-lite loans in the US loan market

Source: Bain Capital

Covenant-lite loans are a type of financing that are issued with fewer restrictions on the borrower with regard to collateral, level of income and loan payment terms, and fewer protections for the lender.

Another alternative asset class – emerging market real estate – may also have slightly higher yields than their developed market peers, according to Khazzam.

However, other regulatory and legal risks could come up, as there are certain markets where the rule of law is not as solidified as in other developed markets, he said.

“Investors need to make sure they are getting paid for the risk that emerging markets bring. If they are not, then they need to be cautious.”


Part of the Mark Allen Group.