With interest rates unlikely to rise in the near future (in fact, rate cuts are expected), investors have become more concerned about finding sources of income.
“The 10-year US treasury has fallen below 2% and when you think about sources of income, there aren’t many viable sources of income today. But actually, there are certain sectors within the alternative space where you can get highly-forecastable sources of income,” he told FSA in a recent interview.
For example, private credit can provide investors yield as high as 10%, he said. Other asset classes in the alternative space, such as transportation leasing, can provide income between 8-10%.
Another benefit that alternative assets provide is that they tend to be uncorrelated to both the traditional asset classes and to other alts, he added.
Core and non-core
Khazzam noted that when looking at alternatives, investors should divide them into two main groups, core and non-core.
Core alternatives are assets in which a large portion of returns are derived from highly-forecastable income, according to Khazzam.
“They create a strong base in a portfolio, as they also act as a cushion to volatility,” he said.
An example of a core alternative is real estate in OECD countries, which include buildings in the residential, retail, industrial and office space.
“These sectors in real estate have been tried and tested. In real estate, you are relying on the leases [that should provide you with forecastable income]. Also, if you look back over the last 20 years, real estate has had half the volatility of global equities,” he said.
Turning to non-core or opportunistic alternatives, Khazzam explained that returns could be in the “high double-digits” (compared to around 5% in core alts), as they are mostly driven by capital appreciation.
“But they are more susceptible to movements within the markets and the economic cycle.”
One example of a non-core alternative is traditional private equity leverage buyout strategies, as returns tend to be more unpredictable.
Asset classes in emerging markets can also be classified as non-core alternatives, he added.
“Real estate emerging markets are non-core. Although they have the the same risks in OECD real estate, there might be other regulatory risks that could come up. There could be different types of legal risks in locations where the rule of law is not as solidified as it could be in other markets.”
Hedge funds, he said, could be either classification.
“It depends on the hedge fund strategy. If the aim of the product is to protect your portfolio, then it would more core. Those that aim to stretch and achieve outsized returns would be non-core.”
When building an alternatives portfolio, Khazzam believes investors should consider allocating to both core and non-core.