Investor appetite for alternatives rising, diversification hunt continues

Institutional investor appetite for alternative investment asset classes is on the rise, with more investors now allocating to alternative asset classes and the main driver continues to be a hunt for diversified returns for their portfolios.

The percentage of investors allocating to three or more different alternative asset classes has risen to 50% in 2018, up from 39% three years ago, according to the latest data from alternative investments specialist data provider Preqin.

Now 79% of the 530 institutional investors surveyed in June 2018 are allocating to at least one alternative asset class and as it is the search for diversification for their portfolios that continues to be the major driver investors are seen to be allocating to an increasing number of alternative asset classes as well.

Amy Bensted, Head of Hedge Funds at Preqin explained, “The diversification benefits of alternative assets continue to attract institutional investors. Four out of five institutions now have exposure to at least one alternative investment fund, and one in ten have exposure across all six asset classes.”

This bodes well for a niche sector like insurance-linked securities (ILS) and the range of reinsurance linked investment opportunities, as it matches the investor demand for diversifying assets that display a low correlation to broader financial markets well.

ILS can perhaps fit alongside the hedge funds that Preqin tracks, where investors are generally looking for 7% or greater returns. But ILS has a much lower correlation with financial markets and in particular equities than the majority of hedge funds, which perhaps means investors return ambitions may be slightly lower, given there are other clear benefits to investing in ILS, in particular the lack of correlation between catastrophes and your typical market movements.

Diversification of returns is cited as the main driver for investing in alternatives, across all types of alternative assets, again an area where ILS and reinsurance can excel.

This is more important than absolute returns for many investors in the space and with return expectations falling in some of the stalwart alternatives, it perhaps suggests that ILS will find its profile raised in the coming year.

“Investors seek to diversify into alternative assets for many different reasons: for private equity, it’s the potential for high absolute returns; for real estate, infrastructure and private debt it is to add a reliable income stream; and for hedge funds to reduce correlation to other assets. Investors also seek a range of returns from these alternative assets – from 7% annualized for hedge funds, to 12% annualised for private equity. Across the alternative assets, most investors have found alternatives to live up to these expectations over the past 12 months,” Bensted continued.

Importantly, investors continue to look for safe haven alternatives where they can be almost certain that a financial or equity market correction will not dent their returns. Again, ILS and reinsurance linked assets over this kind of protection to investors, being an asset class where the movements of equities have little chance of impacting catastrophe or insurance linked returns.

Bensted said, “Alternatives are nonetheless producing strong risk adjusted returns for many investors, and because assets can help protect investors in the event of a market correction, alternatives remain a mainstay of most investment portfolios.”

Overall, investors are keen to increase their allocations to alternative asset classes, with niches looking like one area set to benefit, which could see ILS feature more.

Of course, ILS is limited in terms of size by the availability of underwriting opportunities, a function of the market’s ability to increase its role in major reinsurance programs and to secure more risk from insurers.

The appetite from investors to allocate to true alternatives that provide the diversified returns they seek and that can help to insulate them from financial market fluctuations should ensure that ILS and reinsurance remain a high-profile option for institutional investors at this time and the data from Preqin suggests that this interest will not diminish anytime soon.

Also read: Investors seek diversification within alternatives, positive for ILS.