Home / Analysis / Ditching alts favourites is a ‘big step into the dark’

When is a bubble not a bubble? When traditional monetary transmission mechanisms are disintermediated by private credit. Meanwhile, a decent chunk of so-called ‘alternatives’ are just beta in a low-vol wrapper.

Ask anybody on the street and they’ll tell you that equity markets are still in a bubble – or should at least have stayed flat beyond 2022, instead of recovering most of their losses even as central banks kept ramping up interest rates. But Steve Cain, senior portfolio manager in Janus Henderson’s diversified alternatives team, isn’t so sure.

“Almost universally, and we were very guilty of this, we expected the transition from zero rates to where we are now to be a far bumpier ride,” Cain tells ISN. “We had too much protection on, with hindsight. The key question we have to ask is why? If discount rates moved as much as they did, why did that not reflect in a permanently impaired equity market?”

Part of the answer to that question stems from the growth of private credit, Cain thinks, which has meant there’s been liquidity on hand to expand businesses even as central banks have cut it off at its traditional source by hampering the ability or the willingness of banks to create new loans.

“This growth in private credit is the reason traditional monetary transmission mechanisms are failing. That’s my working hypothesis, and if that’s the case we won’t see that impairment through higher rates until we see private credit slow down in the same way we see banks slow down in a higher interest rate environment – and I don’t see any sign of that.”

“That disintermediation process, until it stops, means we shouldn’t be overly concerned about equities. Are they trading expensive? Yes, on traditional measures. I’m not bullish, but I’m not overly pessimistic because of this new phenomena that I certainly have missed.”

So is private credit in a bubble, then?

“When you see ubiquity in people’s interest in something you immediately say ‘bubble’ – but we could’ve said that about Nvidia a year ago, and it’s still going,” Cain says. “Who am I to decide when that will end?”

Benchmark risk

Still, a lot of so-called alternatives highly prized by the institutional investor set are just beta, Cain notes. Long credit is long beta; long-short with a bias to long is a bias to beta; a lot of private equity turns out to be beta too. But in private equity, benchmarking and peer comparison means investing in something else brings significant career risk.

“The (YFYS) regulations are really making the decision to go with something that doesn’t contribute to a kind of 60/40 portfolio a big step into the dark, which many will take or have taken, and then you have a couple of years where the 60/40 portfolio – last year was a fantastic year for the 60/40 portfolio, we had a big bounce back in bonds and a big run in a very narrow set of equities. That measured portfolio was very hard to beat if you weren’t fully invested in traditional assets.”

“It’s really making it difficult to step outside of that portfolio. But to the extent that private equity looks very beta-ish while delivering, at least expectationally high alpha with low volatility it’s a much easier decision to make because you’re not replacing beta – you’re replacing the wrapper in which beta is being delivered with an apparently lower volatility. It makes it easier to hold that in a traditional portfolio that’s being measured.”

But on the question of whether volatility matters if you don’t see it, Cain is more circumspect.

“If the reality is that you can weather through the storm – which is the appeal of private credit and private equity, which is that we all agree that we’re not going to look at what the value is over time and as long as I come to look at the value at the end of the investment period it’s higher, do we care what the path to that is? It’s the same thing in equities, though you’re obviously going to be told everyday what the path of your returns is.”