Welcome to our monthly digest about investing into alternative assets and digital lending companies, where we cover some of the top headlines from the previous month.
Alternative Assets and Private Debt
- Why Alternative Investments Are Becoming More Mainstream
- Why Do Smart Investors Invest In Alternative Investments Such As Fine Wine?
- Market views: Which alternative assets can best withstand inflation?
- Private Debt Market Set for another 10 Years of Growth
- Private credit booms while deal activity slows
- Alts managers only ones to avoid Q1 declines
Times are changing as more average investors are starting to invest in the alternatives. One of the biggest reasons behind this shift is that people are living longer, meaning that people can take more risk for higher returns.
Alternative investments are also becoming more popular due to geopolitical instability and record high inflation. Global head of private wealth solutions at Blackstone Inc. predicts that alternative investments will be part of 401(k) plans in the near future. Since people are living longer, they’ll need higher returns to save comfortably for retirement.
According to Connection Capital, more than two-thirds of its HNW clients dedicate upwards of 10% of their portfolios to alternative assets such as fine wine. With fine wine one of the most interesting and lucrative alternative investments available, let’s look at exactly why investors are putting it at the top of their portfolio wish lists:
- Diversification: fine wine has a low correlation to traditional markets and therefore provides diversification through reduced risk exposure.
- Potentially higher returns than traditional asset classes: between its launch in 2003 and the end of March 2022, the Liv-ex 1000 index, the broadest measure of the performance of the fine wine market, delivered a total return of 355.2%.
- A hedge against inflation: fine wine is less susceptible to changes in inflation or the wider economic outlook because the primary drivers of fine wine prices are internal factors, including supply/demand, wine quality, and brand prestige.
- Low volatility: fine wine displayed lower volatility over the last 5 years compared to major markets and gold investments.
Asset owners have named inflation as one of their biggest concerns in 2022, with Asian investors more likely to implement inflation mitigation changes in their portfolios. The survey, conducted among fund managers, identified the following strategies where asset owners can find alternative assets for protection against inflation:
- in addition to mainstream assets like inflation-linked bonds, alternative assets such as infrastructure, real estate and private debt can provide protection;
- REITs, especially for the retail, office, and hospitality sectors, provide a great opportunity for an income investor to consider a hedge to inflation;
- picking off the best assets instead of just acquiring large portfolios when deploying capital into a hot sector like single family rentals;
- a mix of commodities producers (mining, energy, and utilities) and real estate companies, blended together as “real assets equities,” can work well in smoothing real returns and diversifying the portfolio;
- real assets with distinct sustainability characteristics like energy storage facilities, are essential and are now at a tipping point where costs have fallen significantly while receiving strong regulatory support.
Investors shall aim to construct portfolios that provide a “good enough” inflation-like exposure (for instance through floating rates) using diverse assets and by choosing attractive opportunities at every given moment. Flexibility and access to the necessary markets is key here.
The past 10 years have been about one thing - growth: growth in terms of the number of private debt funds in the market (from 118 in 2012 to 713 in January this year), number of managers (from 441 to 969) and funds raised (industry AUM was $373mln at the end of 2012 and reached $1.26 bln in Q3 2021).
North America and Europe have provided the generous soil for private debt to grow, given the amount of established middle market sectors, but the next 10 years could see the rest of the world taking the larger share of the pie.
As with any maturing investment, the returns enjoyed by the early entrants (the high teens and twenties) - won’t be as high anymore. But maturity, competition and innovation do not mean fewer opportunities: the private debt market is still embryonic in the grand scheme of the overall investment management universe.
Volatile public markets and interest rate increases could lead more investors to boost their exposure to private credit at a time when the same economic factors are threatening to slow transaction activity in 2022 private equity firms - main customers of credit managers. Already in 2022, global private credit and private equity transactions are down from 2021 levels. At the same time, capital is continuing to pour into the private credit asset class, and credit managers are continuing to have success raising new funds in 2022.
Private debt, particularly direct lending, is a better substitute for fixed income, which has been the biggest drag on investors' portfolios. Private debt yields are higher and are floating rate, so they go up with interest rates, and volatility is about the same as investment-grade bonds. In 2021, private credit earned back the declines suffered the year before when returns were hit by the pandemic. This year, private credit should produce the yield investors expect.
Weak markets, inflation and investors' geopolitical worries lead to AUM drops for most. According to data compiled by Pensions & Investments, among 25 U.S. asset managers that had reported first-quarter results by May 5, only six — all alternative asset specialists — saw their assets under management climb over the past quarter, while the bulk of firms suffered losses in AUM.
The six alternative asset managers that saw their AUM increase in the first quarter — The Carlyle Group, up 8%; Blue Owl Capital Inc., up 7.9%; Ares Management Corp., up 6.3%, Blackstone Inc. up 3.9%; Apollo Global Management Inc., up 3.1%; and KKR & Co. Inc., up 1.8% — generally attracted inflows into alternatives or pumped up AUM via acquisitions.
- Startups now have another alternative to VC: growth through debt
- How neobank digital lending will disrupt financial services
- Curious About Crypto Lending? What Consumers Should Expect
- Digital Revolving Credit: Builds on the Pros and Reduces the Cons of Buy Now, Pay Later and Credit Cards
- ‘Buy now, pay later’ will soon affect your credit score in the UK
As Europe's startup ecosystem has matured, founders are raising capital in more diverse ways, including asset-backed lending, as new European and established US debt firms are increasingly offering this kind of capital to startups. Debt is eagerly used by the founders for certain elements of business that are scalable.
Some of the key perks of debt versus equity funding: there’s no need to give up ownership in the company, also, interest rates are lower on the debt than compared to the kinds of returns equity investors might be expecting. Interest on early-stage asset-backed lending can be typically in the 8-15% range, that compares to less than 6% for bank financing.
Founders are recommended to raise equity for investing in things that will grow the business, like hiring people, “because equity is so expensive”, and start looking to debt, when there are assets generating profits already.
Fintech lending is expected to reach a global value of $27.1bn by 2028, growing at an annual rate of 18.13%, according to Verified Market Research. The proliferation of start-ups in the space demonstrates that this banking segment is on the rise. The trend for digital lending has vast adoption potential in ‘underbanked’ regions such as Africa, where only 43% of the population has a traditional bank account. This trend seems set to go global, although China has outlawed its adoption.
The issue of fair and transparent lending decision-making has become the focus of regulators worldwide. The technology that underpins digital lending directly addresses this problem through transparent and uniform algorithmic decision-making, but perhaps more importantly, it provides options for the lack of credit rating for the world’s unbanked population. However, the issue of privacy and data rights still has to be resolved. In 2020, South Korea became the first country in the world to establish laws dedicated solely to digital lending, providing credibility and validation to digital lenders. As with all emerging market segments, regulation and adoption protocols are still in progress, and in the absence of regulation, many digital lenders are applying for banking licences.
By allowing individuals to use their crypto assets as collateral to borrow cash, crypto loans are revolutionizing the lending industry by giving access to consumers that have been shut out of conventional lending for far too long. With crypto lending, consumers unable to secure a traditional loan because of the bank’s minimum deposit requirement or a low credit score now have options available to them. Not only that but consumers can also lend their own crypto assets, depositing them into an interest-bearing account to generate passive returns.
4. Digital Revolving Credit: Builds on the Pros and Reduces the Cons of Buy Now, Pay Later and Credit Cards
Digital Revolving Credit has emerged as an attractive alternative for e-commerce merchants and their customers. This method blends many of the advantages of BNPL solutions and conventional credit cards while avoiding some of their pitfalls.
One major advantage of Digital Revolving Credit is that it is not constrained by a fixed payment schedule. Consumers can structure their payment schedule to meet individual budgets and needs. Furthermore, an account can be opened once and used again and again indefinitely, as long as the customer remains in good standing. That’s attractive to merchants who sell products that lend themselves to repeat purchases, or even subscriptions. Finally, Digital Revolving Credit allows merchants to form long-term relationships with their customers, providing an incentive for shoppers to continue to use their credit line on a recurring basis. Rather than “Buy Now Pay Later,” this method could be more aptly described as “Buy Often Pay Flexibly.”
Starting June 1, Klarna will share data on whether Brits paid off a “buy now, pay later” loan in time to the credit bureaus TransUnion and Experian, meaning such data will now start to appear on their credit reports. Klarna has around 16 million users in the country. The development could deter shoppers from using the company’s services, as it will now affect their credit history. Credit reporting is a double-edged sword in that it can be used to punish borrowers but also to incentivise and reward healthy financial habits
Customers’ credit scores are expected to be impacted by the change in the next 12 to 18 months, Klarna said. It comes as the U.K. government is looking to bring in regulation for the BNPL industry by 2023.