There are asset classes that insulate portfolios against public equity exposure in case of an economic slowdown. When interest rates rise, the cost of capital for corporations to borrow money increases. Less business spending can slow company growth. Higher interest rates can lead to decreased earnings per equity share.1 Both of these factors can influence the price of stock, although the relationship is more than a degree removed from that of bonds to interest rates.
44% of Advisors said they are looking for non-correlated returns
Interest Rate Protection
Private placements, while not uncorrelated to interest rates, can offer interest rate protection, especially against short term fluctuations. Private placements can be equity, debt or a hybrid. A variety of combinations of structuring elements will create a range of correlation to public equity and bond markets. Because many private securities are illiquid and not traded on a secondary market, their prices do not fluctuate by short term supply and demand spikes, even though their value may.2 For portfolios that face mark to market pressure, private placements can provider a buffer as to stated returns.
Some asset classes, for example single and multifamily real estate rentals, are somewhat protected against risk associated with interest rate spikes and declines. An increase in rates is often correlated with inflation of “real assets”, such as real estate. There is a strong correlation between rents, interest rates, and inflation. When interest rates rise, a real estate property manager can generally adjust rental rates annually (unless constrained by contractual limits), while experiencing higher absolute appreciation on the asset itself.3
Hidden Benefit of Illiquidity
In May of 2018, Andrew Ang et al. published estimates of private equity returns based on quarterly cash flow to limited partners (LPs) in the Journal of Finance. The team ran Monte Carlo simulations with listed stocks as the underlying investments to test the methodology. The team used Preqin and Burgess data sets for investments and distributions. The study found that consolidated venture capital returns fell in the mid-2000s, remained flat until 2012, and then began to sharply increase. These rates of returns effectively rode out the 2008 economic downturn.4
- “Chapter 13: Investing in Real Assets.” The Stewardship of Wealth: Successful Private Wealth Management for Investors and Their Advisors, by Gregory Curtis, Wiley, 2013
- See 2
- Ang, Andrew et al. “Estimating Private Equity Returns from Limited Partner Cash Flows.” The Journal of Finance. 10 May 2018