Senior associate of NIC A. Kussainova interviewed Head of Strategy Department Arman Muslimov, CFA on the impact of COVID-19 pandemic on the alternative investments market.

- Summing up 2020 results, how would you describe what happened in global capital markets and how did that affect markets of alternative investments?

- The last year was unusual for the markets for several reasons.

First, despite the pandemic, stock markets recovered quickly and even showed growth for the year. This was possible due to unprecedented monetary and fiscal stimulus measures from central banks and governments around the world, which had learned from past financial crises.

Secondly, despite the fact that the market showed growth on average, different sectors and companies recovered differently. For example, it is no secret to anyone that growing technology and healthcare sectors were the most attractive during the last year. Whereas more mature and traditional (value) companies lagged significantly behind.

Overall these trends have had a positive effect on many investments in the alternatives space. For example, investments in private capital have a natural bias towards growing companies in prospective sectors. In addition, high volatility in stock markets and their uneven recovery created a favorable environment for hedge funds, which were able to apply their skills and show excess returns (alpha).

- What measures have been taken by portfolio managers of alternative investments to reduce risks and increase returns during this period of high uncertainty?

- Despite the fact that the markets showed growth on average, there was a large difference between winning and losing managers depending on factors such as investment strategy, decision-making discipline, risk management, length of successful experience, including in periods of past crises, and other factors.

Established relationships among investors, managing funds and other participants of capital markets allowed institutional investors not to stop investments in the less liquid part of the portfolio in order to maintain diversification by vintage years. This is especially important for investors at this stage, because historical data show that investments made during periods of crises and immediately after crises often perform better in a long term than investments made in stable times.

In spite of travel restrictions, measures taken to ensure operational continuity and adaptation of processes of all market participants allowed to build a solid foundation for sustainable portfolio growth over the long run. Peculiarity of alternative investments is that many of them have a long-term investment horizon and current results of successful investors should be attributed to patient and hard work of building portfolios and choosing funds over the past years.

- What challenges do investors expect in the near future?

- Despite recovery of the global economy and optimistic expectations, the situation on capital markets is currently unstable. With the strongest economic recession in most countries and growth of unprofitable companies, stock markets hit new all-time high levels several times. On the one hand, this creates fragility of the financial system, but on the other hand, with further growth of money supply and acceleration of inflation of financial assets, institutional investors need to preserve real value of the capital under management.

In addition, competition among investors for the alternative investments is growing. More and more major institutional investors are increasing their share of allocation in these assets due to their attractiveness in terms of both high expected absolute returns and diversification. This is happening for two main reasons. First, flow of retail investors and development of investment vehicles, such as exchange-traded funds, have been increasing demand for traditional financial assets, reducing their return. These trends are likely to accelerate with further development of fintech industry and growing capacity of data analysis. Secondly, permanent expansionary monetary policy, large amounts of liquidity, and as a result, growing valuations of financial assets also force investors to look for new opportunities. For example, according to long-term forecasts of many asset managers, highest absolute returns are expected in the private capital market. In addition, low yields and decreasing diversification benefits of bonds increase attractiveness of certain strategies of hedge funds, due to their low correlation with equities and higher expected returns compared to bonds. Therefore, the growth of investors’ interest in these asset classes is natural.

To sum up, taking into account that global economy is expected to grow, while instability of capital markets is likely to persist, diversification strategies will play an important role to preserve real values of portfolios in different scenarios. Given current market conditions, mentioned benefits of alternative investments in terms of absolute return and diversification are gaining more relevance for portfolios of long-term investors.