As a new administration takes the reins in Washington, economic and financial market conditions continue to be in a perpetual state of flux. Questions around tariffs, deportations and Federal Reserve independence — unfolding in fits and starts against a backdrop of sticky inflation and stretched valuations — have investors and business leaders on edge. Uncertainty about the rapidly evolving outlook for generative artificial intelligence has only added punch to the daily volatility. At times, markets can seem only one headline away from a particularly eventful day. Though the future is inherently unknowable, what tomorrow may bring might never have seemed more unpredictable.
Historically, the antidote to volatility has been diversification, i.e., constructing portfolios whose various parts zig while others zag. The Nobel Laureate economist Harry Markowitz went so far as to say that diversification is “the only true free lunch in investing.” Of course, the various servings that make up an exceptional meal aren’t always equally tasty, even though they may complement each other and make the whole greater than the sum of the parts.
That is precisely what diversification is designed to do, while also recognizing that adding ingredients to an optimally diversified portfolio may cause it to underperform the top-performing asset in any given period. A well-diversified portfolio is constructed using asset classes driven by different macroeconomic factors; what might be good for equities won’t necessarily be good for fixed income, and vice versa. For that reason, asset classes — and the subsectors within them — rarely move in lockstep. Over time, however, a diversified portfolio usually can outperform those chasing the investment flavor of the day, especially on a risk-adjusted basis.
In recent years, access to so-called alternative investments, a group that includes private equity, private credit, private infrastructure, private real estate and hedge funds has evolved to give investors a means to boost diversification by owning assets with lower correlations than those typically found in public markets. Over long periods, a portfolio containing less-correlated assets will likely generate smoother returns with dampened volatility. From 2005 through 2021, for example, U.S. private equity, global private real estate and private debt each generated an excess return per unit of risk, as measured by the Sharpe Ratio.
Since 2000, the number of private-equity backed assets has grown six-fold, even as the number of public U.S. businesses has shrunk by about 40% over roughly that same period. In fact, only a tiny fraction of U.S. businesses trade on public markets — and for understandable reasons. Private companies typically encounter fewer regulatory obstacles than their public counterparts, and they are generally freer to execute long-term plans without having to satisfy shareholder expectations for quick results each quarter. That broader perspective can make private businesses attractive as long-term holdings.
Additionally, private markets provide investors with access to truly transformative innovations, including businesses involved in artificial intelligence and electrification. The rapid growth of AI and cloud computing, for example, is driving demand for data centers and digital infrastructure, which in turn creates the need for vast increases in electricity output. According to the International Energy Agency, meeting AI-related power requirements will require $3 trillion in annual investments by 2030. Meanwhile, large technology companies are projected to invest up to $250 billion in data center expansion this year alone, with leading firms anticipating a year-over-year growth rate approaching 50% in capital expenditures. Clearly, expanding electricity production to meet heightened demand from AI, electric vehicles and various industrial processes will require massive capital expenditures across the value power chain.
Similarly, private credit could enhance diversification while boosting current income as well. Private loans have tended to produce high single- to low double-digit returns, in addition to generating a yield premium relative to that available in the public fixed-income markets.
Finally, hedge funds are known to deliver returns that are less correlated to traditional stocks and bonds by exploiting market inefficiencies and abrupt shifts in the global macroeconomic environment — especially in periods when stock dispersion levels are elevated.
The Burish Group at UBS has decades of experience in navigating the expanding universe of alternative investments and private markets. Depending upon liquidity requirements and risk tolerance levels, we believe that investors might consider replacing 20% to 40% of their exposure to public assets with those from alternative and private asset classes. Diluting risk by adding non-correlated assets to a portfolio is a strategic antidote for these uniquely uncertain times.
Call The Burish Group today at 262-794-0872 for a second opinion on your financial plan.
The Burish Group specializes in holistic wealth management for affluent individuals and families. With over 40 years in business at UBS, we are dedicated to solving our clients’ most complex financial situations.
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The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. Investors should be aware that alternative investments are speculative, subject to substantial risks (including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments), may involve complex tax structures, strategies and may not be appropriate for all investors. Asset allocation and diversification strategies do not guarantee profit and may not protect against loss. The views expressed herein are those of the author and may not necessarily reflect the views of UBS Financial Services Inc.
Andrew Burish is a financial advisor with UBS Financial Services Inc., a subsidiary of UBS Group AG. Member FINRA/SIPC in 8020 Exclesior Drive, Madison, Wisconsin.
