Beyond Beta: How to Use Alternatives to Replace Public Equity

A purpose-built portfolio of alternatives can replicate the return profile of public equities while mitigating key vulnerabilities of the asset class—namely high volatility, elevated inflation sensitivity, and a shrinking investable universe. In this paper, we explore what such an alts portfolio can look like and discuss practical considerations to replacing public equity with alternatives.

DOWNLOAD THE WHITE PAPER

Key Takeaways

  • A series of secular changes affecting public equity markets and a surge in inflation have accentuated some of the vulnerabilities of public equities as an asset class. Public equity markets are becoming more concentrated and less viable as a source of alpha. The asset class is also susceptible to inflation and subject to high levels of volatility.
  • In crafting this paper, we asked the question: Can we build a portfolio able to keep the positive traits of public equity—namely relatively high returns—while mitigating its unwanted vulnerabilities?
  • In a word: Yes. Our work shows that replacing some public equity allocations with a portfolio consisting of private equity, private debt, and real assets can deliver potential returns on par with or above those of public stocks, while reducing volatility, providing enhanced protection against inflation, and expanding the investable universe.
  • Building and maintaining this type of alternatives portfolio is a complex and demanding task. Investors will have to contend with new challenges, such as liquidity and vintage risks, manager selection and access, and cashflow management.
  • Asset managers are offering new solutions that aim to mitigate the challenges and simplify the process of investing in alternatives. These solutions can make it practical for both institutional and individual investors to enhance potential risk-adjusted portfolio returns by replacing some of their public equity allocations with alternatives.
DOWNLOAD THE WHITE PAPER

The information herein is provided for educational purposes only and should not be construed as financial or investment advice, nor should any information in this document be relied on when making an investment decision. Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change. Please see the end of this document for important disclosure information.


Important Disclosure Information

This presentation is for educational purposes only and should not be treated as research. This presentation may not be distributed, transmitted or otherwise communicated to others, in whole or in part, without the express written consent of Apollo Global Management, Inc. (together with its subsidiaries, “Apollo”).

The views and opinions expressed in this presentation are the views and opinions of the author(s) of the White Paper. They do not necessarily reflect the views and opinions of Apollo and are subject to change at any time without notice. Further, Apollo and its affiliates may have positions (long or short) or engage in securities transactions that are not consistent with the information and views expressed in this presentation. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Target allocations contained herein are subject to change. There is no assurance that the target allocations will be achieved, and actual allocations may be significantly different than that shown here. This presentation does not constitute an offer of any service or product of Apollo. It is not an invitation by or on behalf of Apollo to any person to buy or sell any security or to adopt any investment strategy, and shall not form the basis of, nor may it accompany nor form part of, any right or contract to buy or sell any security or to adopt any investment strategy. Nothing herein should be taken as investment advice or a recommendation to enter into any transaction.

Hyperlinks to third-party websites in this presentation are provided for reader convenience only. There can be no assurance that any trends discussed herein will continue. Unless otherwise noted, information included herein is presented as of the dates indicated. This presentation is not complete and the information contained herein may change at any time without notice. Apollo does not have any responsibility to update the presentation to account for such changes. Apollo has not made any representation or warranty, expressed or implied, with respect to fairness, correctness, accuracy, reasonableness, or completeness of any of the information contained herein, and expressly disclaims any responsibility or liability therefore. The information contained herein is not intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. Investors should make an independent investigation of the information contained herein, including consulting their tax, legal, accounting or other advisors about such information. Apollo does not act for you and is not responsible for providing you with the protections afforded to its clients.

Certain information contained herein may be “forward-looking” in nature. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking information. As such, undue reliance should not be placed on such information. Forward-looking statements may be identified by the use of terminology including, but not limited to, “may”, “will”, “should”, “expect”, “anticipate”, “target”, “project”, “estimate”, “intend”, “continue” or “believe” or the negatives thereof or other variations thereon or comparable terminology.

The Standard & Poor’s 500 (“S&P 500”) Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value.

Additional information may be available upon request.

It Is Taking Time for the Fed to Remove the $10trn Stimulus Done During Covid

The consensus has been forecasting negative growth since October 2022, and the recession has yet to arrive because it has taken longer to run down excess savings in the household sector, see chart below.

Put differently, it is taking longer to remove from the economy the $5trn fiscal and $5trn monetary expansion done during covid.

On the back of stronger-than-expected growth, the correction in stock markets and credit spreads has been relatively limited despite the rapid increase in short rates.

With inflation still at 5%, far above the Fed’s 2% inflation target, the Fed will keep the costs of capital high, and the recession will come as households eventually run out of excess savings.

The implication for markets is that the Fed will continue to put downward pressure on earnings growth and employment growth until they get what they want, namely lower inflation.

Source: Bloomberg, Apollo Chief Economist

Recession Perspectives

Based on data from retail sales and jobless claims from last week, we continue to see a gradual slowdown in the economy. This week, the Federal Reserve will release the minutes from their last meeting, and we’ll be looking for signals around why they recently chose to raise rates and what that could mean for their decisions ahead. The consensus is expecting a recession. In this edition of the Weekly Brief, we look back at prior recessions and how they compare to the current market environment. What we’re likely going to see in the coming months is a correction coming not as much in the economy, but in asset prices as the Fed continues to deflate the bubble it created due to 15 years of global easy money. A mild economic recession with a big recession in asset prices is what we call a non-recession recession.

This presentation may not be distributed, transmitted or otherwise communicated to others in whole or in part without the express consent of Apollo Global Management, Inc. (together with its subsidiaries, “Apollo”).  

Apollo makes no representation or warranty, expressed or implied, with respect to the accuracy, reasonableness, or completeness of any of the statements made during this presentation, including, but not limited to, statements obtained from third parties. Opinions, estimates and projections constitute the current judgment of the speaker as of the date indicated. They do not necessarily reflect the views and opinions of Apollo and are subject to change at any time without notice. Apollo does not have any responsibility to update this presentation to account for such changes. There can be no assurance that any trends discussed during this presentation will continue.   

Statements made throughout this presentation are not intended to provide, and should not be relied upon for, accounting, legal or tax advice and do not constitute an investment recommendation or investment advice. Investors should make an independent investigation of the information discussed during this presentation, including consulting their tax, legal, accounting or other advisors about such information. Apollo does not act for you and is not responsible for providing you with the protections afforded to its clients. This presentation does not constitute an offer to sell, or the solicitation of an offer to buy, any security, product or service, including interest in any investment product or fund or account managed or advised by Apollo. 

Certain statements made throughout this presentation may be “forward-looking” in nature. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking information. As such, undue reliance should not be placed on such statements. Forward-looking statements may be identified by the use of terminology including, but not limited to, “may”, “will”, “should”, “expect”, “anticipate”, “target”, “project”, “estimate”, “intend”, “continue” or “believe” or the negatives thereof or other variations thereon or comparable terminology.

The ICR for the IG Index Looks Good

The interest coverage ratio for the investment grade index is currently near all-time high levels, see chart below.

High quality credit is in excellent shape
Source: Bloomberg, Apollo Chief Economist

A Non-recession Recession

What makes the coming recession so unusual is that it is happening after almost 15 years of money printing, which never really had any major positive effect on GDP growth. Instead, the 15 years of money printing created a significant bubble in asset prices.

As a result, the big correction during this recession will not be in the economy but in asset prices as the Fed continues to deflate the buy-everything bubble created due to global easy money.

A mild economic recession with a big recession in asset prices is what we call a non-recession recession.

With inflation currently at 5%, well above the Fed’s 2% inflation target, the ongoing correction in asset prices will continue as the costs of capital will stay elevated well into 2024.

GDP and unemployment rate change during recessions
Source: BEA, Haver Analytics, Apollo Chief Economist. Note: Estimates shown for real GDP and nominal GDP are for the period covering the peak-to-trough decline in real GDP. Unemployment rate is trough to peak.

Milder but Longer Slowdown

The stock of CRE debt outstanding today is significantly smaller than the stock of residential mortgage debt outstanding in 2007, see chart below. 

As a result, this recession will be milder than in 2008, but it will likely be longer because the required correction in CRE prices will be spread out over a longer period.

This recession will be milder than in 2008
Source: BEA, FRB, Haver Analytics, Apollo Chief Economist

The Fed Is Trying to Cool Down the Economy

A survey of 67 banks in the Dallas Fed district carried out in early May shows that credit standards have tightened significantly since SVB collapsed, and bank credit conditions are now at 2020 levels, and the deterioration continues, see chart below.

Combined with still tight IG and HY spreads, the Fed will look at this and conclude that tighter credit conditions are needed to get inflation down from currently 5% to the Fed’s 2% inflation target. In particular in a situation where households are still sitting on plenty of cash, see also this new Fed working paper, which finds that consumers have plenty of excess savings left at least until the end of the year.

Credit standards at 2020 levels and deterioration continues
Source: Banking Conditions Survey, Federal Reserve Bank of Dallas, Apollo Chief Economist. Note: Data were collected May 2–10, and 67 financial institutions responded to the survey headquartered in the Eleventh Federal Reserve District.

Consensus Expects a Hard Landing

The consensus expects a recession starting next quarter, but the upside risk to this negative forecast is that consumers still have plenty of savings left, see also this new Fed paper, which finds that households will not run out of excess savings before the fourth quarter of 2023.

The consensus expects negative growth for the coming three quarters
Source: Bloomberg, Apollo Chief Economist