Alternative Investments - KKR Outlook

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🔍 What are Alternative Investments?

Alternatives encompass a range of assets, including Private Equity, Venture Capital, Infrastructure and Private Credit. Unlike stocks and bonds, they don’t trade publicly and often involve longer investment horizons. This illiquidity can be an advantage, giving investors access to a potential premium.

Interest in Alts has been rising steadily and is expected to grow from $16.8 trillion in 2023 to $24 trillion by 2028. It’s clear that these assets have become essential tools for investors seeking yield, inflation protection, and low correlation with traditional markets amid today’s uncertain economy.

🌐 Why Alternatives Matter for Diversification

Diversification has always been a cornerstone of sound investing, but it’s becoming increasingly complex in today’s environment. As correlations between traditional asset classes such as stocks and bonds rise during economic uncertainty, investors need options to diversify. This is where Alts come in.

Unlike traditional assets, Alts typically have distinct risk and return profiles. They react differently under various economic scenarios, making them ideal for balancing a portfolio. Diversifying by adding alternatives to one’s portfolio is becoming more common, with investors keen on adding sub-classes like infrastructure or real estate, which often bring stability, while private equity and venture capital drive growth potential.

In essence, Alts provide an extra layer of security, offering portfolio diversification beyond what stocks and bonds can sometimes deliver.

📊 Understanding Risk and Return Profiles

Grouping all Alternatives together can be misleading. Different types of Alts vary widely in terms of risk and return. As shown by KKR below, realized returns and volatility can range significantly. For instance, PE and VC have historically offered high returns but come with greater volatility, while core infrastructure and certain types of private credit tend to show more stability and may offer inflation protection.

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💼 Breaking Down Alts by Asset Class

As KKR’s report illustrates, not all alternatives are the same. Each category within private markets has distinct risk, return and liquidity profiles, allowing them to meet different portfolio needs.

Private Equity

• Private Equity has shifted from a buyout-focused approach to one centered on operational improvement. Originally emerging through pension fund regulatory changes in the 1970s and later fueled by the expansion of high-yield debt markets, PE firms today provide both capital and strategic guidance.

• Core Private Equity, a long-term, compounding-focused approach has recently gained traction. It contrasts with more traditional buyout funds by focusing on sustained, incremental growth over time rather than rapid, high-risk expansion. It appeals to investors seeking steady capital appreciation rather than short-term gains.

• The PE market is still modest relative to its total addressable market, even as PE holds an increasingly large share of private company value. KKR projects significant growth potential for PE, especially in high-quality sectors such as technology, healthcare and infrastructure, which benefit from long-term trends like digitalization and demographic shifts.

Private Credit

• With banks scaling back on certain loans, Private Credit stepped in, particularly for mid-sized companies and niche sectors. The report highlights growing diversification within Private Credit, from asset-based finance (ABF) to mezzanine and distressed debt.

• ABF has grown in popularity, especially since the 2023 regional banking crisis, as loans are secured by hard assets such as real estate, intellectual property, or even equipment, appealing to investors seeking inflation-protected, collateral-backed investments.

• Another growing area within Private Credit is the SRT market, where banks sell credit risk on loan portfolios to private investors. The U.S. SRT market is expanding due to new capital regulations, presenting a key opportunity for private credit managers.

Private Infrastructure

• Private Infrastructure is a core pillar of portfolio construction, offering stability, inflation protection, and diversification. KKR’s report shows this asset class is transitioning from private wealth allocations in the 1990s to a crucial investment channel filling gaps left by governments’ limited infrastructure budgets.

• Private infrastructure assets deliver steady cash flows and resilience against economic fluctuations, appealing to investors seeking downside protection and inflation-adjusted returns. With inflation cooling, its yield potential may become even more attractive.

• Key infrastructure drivers include decarbonization, digitalization, and geopolitical shifts, with investments in renewable energy, data centres, and supply chain reshoring aligning with sustainability and security goals.

Real Estate Private Equity

• Real Estate Private Equity (REPE) has evolved from a niche distressed-asset strategy to a core component of alternatives, generating stable returns while hedging against market volatility. KKR highlights opportunities across both equity and debt, offering flexible strategies to meet investor needs.

• Real Estate Debt is gaining traction as a conservative alternative, offering steady cash flows backed by physical assets. With banks retreating, private lenders are stepping in to capture higher yields, appealing to investors seeking income with lower risks.

• On the equity side, REPE has shifted from traditional Office and Retail sectors toward Multi-family, Industrial and data centers. Core strategies focus on stabilized, income-producing properties, while opportunistic strategies target redevelopment projects in urban or high-growth areas.

📈 Alts and the Shift in Economic Regimes

We are witnessing a notable shift in economic regimes. Gone are the days of near-zero interest rates and low inflation. Today’s environment of higher rates and inflation has reshaped asset allocation strategies. Traditional portfolios, like the classic 60/40 stock-bond mix, are less effective when both asset classes struggle to balance each other’s risks.

Alts offer alternative sources of return and diversification well-suited to this new environment. The figure below shows that a portfolio with a 30% allocation to Alts, balanced with stocks and bonds, has historically outperformed the 60/40 mix on a risk-adjusted basis. This approach creates a more “all-weather” portfolio that can better withstand inflation-driven volatility and growth shocks.

🔒 Harnessing the Illiquidity Premium in Alternatives

One of Private Alts’ core appeals is the potential for an illiquidity premium. Investors willing to commit capital for longer periods may receive higher returns as compensation. For institutions like pension funds and endowments with long investment horizons, this trade-off is highly attractive. Their ability to allocate more significantly to illiquid assets without needing immediate liquidity allows them to capture this premium over time.

However, for individual investors or organizations with near-term cash flow needs, the illiquidity premium requires careful planning. Evergreen funds, a growing structure within Alternatives, offer a middle ground by providing periodic redemption opportunities while maintaining exposure to private markets.

Understanding the illiquidity premium is critical for any investor considering these types of investments. For some, it’s a valuable source of extra return; for others, it may carry risks if liquidity needs aren’t carefully assessed.

✒ Conclusion

Alternatives have become essential for building portfolios that can adapt to an ever-changing economic landscape. As traditional assets face potential headwinds, Alts offer a pathway to broaden returns, hedge against inflation, and tap into unique growth potential.

Integrating Alts effectively requires thoughtful planning, strategic allocation, and a clear understanding of their specific benefits and risks. With a well-crafted approach, these assets can enhance a portfolio’s resilience and open doors to new opportunities.

If today’s insights sparked any thoughts or questions, feel free to reply – I’d love to discuss how Alts could fit into your portfolio strategy.

Until next time,
PE Bro

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Disclaimer: The insights shared in this newsletter are based on my independent analysis of KKR’s report on alternative investments. They do not represent the views of KKR and should not be taken as an endorsement by KKR. This is not financial advice.