In a prolonged low interest rate environment, where monetary support from central banks is still propping up financial systems, and global trade wars and Brexit continue to take a toll on confidence, investors are being pragmatic. Alternative investment strategies, including private equity and private debt, which have always been secondary to listed equities and bonds, are coming under the spotlight.

Front of mind is the hunt for yield and a demand for inflation-proof investments. In the private capital arena, investors are after assets that will not only give them a return after a time, but ideally deliver cash along the way as well. If assets are uncorrelated to mainstream market movements too, helping to further spread sources of risk and return within portfolios, so much the better.

What is hot in the current climate

Within alternative funds, there is a huge variety of asset types and strategies, and as with portfolio diversification in general, investors should try to have fingers in many different pies. Decisions around what to include will of course vary from investor to investor, but it is worth looking at which fund strategies have the most potential in the current climate, before entering this space or increasing allocations to alternatives. Sterling-based investments are preferable right now, but beyond that, in my view, some of the most attractive areas of opportunity currently include:

ESG funds

Ethical, Social and Governance-focused investments are a fast-growing area, and demand for socially and ethically conscious or ‘green’ assets is unlikely to subside any time soon. Long-dated, cash-generative funds investing in green energy infrastructure is one exciting option, especially as companies (led by the likes of Apple and Facebook) are keen to demonstrate their carbon neutrality.

“Within alternative funds, there is a huge variety of asset types and strategies, and as with portfolio diversification in general, investors should try to have fingers in many different pies.”

Private debt and other credit strategies

At this late stage in the credit cycle, private debt/credit strategies where investors occupy a senior position in the capital structure and where lending is cashflow or asset-backed, hold strong appeal. Their cash-generative nature mitigates the J-curve associated with returns from some other types of alternative assets.

Private equity/venture capital strategies with an edge

Technology continues to dominate venture capital appetites, with tech businesses that can break down geographical barriers and make markets more efficient, in high demand. Outside that competitive sphere, private equity strategies that can differentiate themselves from other private equity funds, for example by focusing on a specific niche or an overlooked market segment such as smaller management buyouts (which have outperformed larger buyouts according to the most recent British Venture Capital Association data), can be rewarding. So too, those with a value-adding strategy such as a ‘buy and build’ approach.

Distressed credit/special situations

Economic uncertainty brings with it increased risk of corporate distress and market dislocation, so it’s possible that opportunities will increase for specialist strategies which can acquire underperforming assets at a discount and restructure them to maximise returns.

Property with a purpose

It pays to be selective about property investments today, though the prospect of yield is attractive. Strategies that tap into growth areas of the market (such as logistics warehouses), build scale (in fragmented sub-sectors like shared student housing) or fill market gaps (by providing short-term working capital to developers, for instance), are areas to watch.

Uncorrelated opportunities

Assets whose performance bears little or no relation to peaks and troughs in equity or bond markets have come into their own, for obvious reasons. Litigation funding, where court cases are decided without reference to the wider economy, and life sciences funds, whose success relies on developing medical treatments, are two examples. More esoteric options like wine, fine art, stamps or music royalties also come under this heading, but proceed with caution.

Approach with care

Clearly, many of these strategies are highly niche or emerging, and so they require specialist expertise to make them work. Identifying attractive areas to invest in is one thing; finding a fund manager with the skills and track record to make such strategies work from entry to exit, structuring them appropriately, is another. The choice of fund manager is as important as the underlying assets themselves.

Take music royalties. This sounds like an exciting place to invest, given the enduring appeal of new music and artists’ back catalogues, and it is an area many people are interested in. However, this type of investment is likely to be more complex to structure, and therefore, to exit with a worthwhile return, than it first appears.

Making the most of market conditions

Trying to read the market is always difficult and the risk of mistiming entry looms large. A better plan of attack is either to choose strategies that play into where we are in the cycle to capitalise on market trends, or that provide an inflation-hedge or a cash-play to mitigate today’s low interest rate environment.

In the current climate, good alternative strategy opportunities can exist almost anywhere but it requires experts with the know-how to identify and capitalise on them. My advice is not to focus on asset type alone but pick strategies that have more predictable outcomes and consider the quality of the fund manager and the value-add they can deliver. That is where the most attractive opportunities really lie.

Lorna Robertson is head of funds at Connection Capital.

This article originally appeared in Investment Week on 11 October 2019.