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A risk-based approach to harnessing alternative sources of income

Optimizing outcomes through alternatives

The income-generating potential of alternatives seems to be largely underappreciated, despite the trend toward larger allocations to alternative asset classes and the need for yield. Investors can enhance their ability to capitalize on the yield and diversification benefits of alternatives by focusing on the risks that drive returns in each specific segment of the alternatives universe. Executing this, however, is no simple task. If done incorrectly, investors risk negating some of the diversification benefits that make alternatives such valuable contributors to stronger, more resilient portfolios.

Nuveen experts explore risk analysis across income-generating asset classes, including key considerations related to the coronavirus pandemic and offer a distinct framework for risk factor-based portfolio construction.

  • Alternative asset classes such as private credit, real assets (farmland, timberland and private equity infrastructure investments) as well as non-traditional sectors of fixed income (preferred securities, emerging markets debt, high yield corporate debt and leveraged loans) present attractive income-generating potential.
  • Idiosyncratic risks play a vital role in driving returns in each of these asset classes — and these risks are what institutional investors should be trying to harness in an income-generating multi-asset portfolio. But it is important to note that each of these asset classes has significant exposure, in varying degrees, to the core, broad-based risk factors: equity, credit spread and rate duration.
  • As the chart below illustrates, idiosyncratic risks account for less than 60% of the contribution to total risk in most of the alternative asset classes included in the chart. With emerging markets debt, for example, equity risk accounts for 36% of the total risk and credit risk accounts for an additional 33%.
  • Preferreds are also an interesting case. Some investors consider them to be more like an equity instrument while others consider them to be more like fixed income. This debate is easily settled when viewed through a risk decomposition lens, which shows that equity risk and idiosyncratic risk account for the totality of risk for preferreds.

Decomposing risks across asset classes 

Fixed income

The non-traditional, or “plus,” sectors of fixed income present attractive yields for investors seeking enhanced income. Opportunities in these sectors are continuously shifting, emphasizing the need to take a diversified and dynamic investment approach. We examine several nuances of the return drivers in these sectors that investors should consider.

Private credit

U.S. senior middle market loans have typically yielded between 6% and 8% since 2010 and the illiquidity premium has averaged 1.8% during the period, according to LC/S&P Global. This has provided a boost to yields, making middle market loans an effective alternative source of income. We explore their risk profile, which varies significantly from other types of debt.

Real assets

Real assets have proven to be exceptional stores of value and defensive income generators because they provide products or services that are essential to the global economy. We explore the risk factors that drive the value of these assets, which are highly idiosyncratic, and other factors that vary from asset to asset.

Real estate

Investors often cite diversification as the primary reason to invest in real estate. But the diversification benefit of real estate is largely the result of the quality and security of the income stream associated with real estate investments. We explore the megatrends driving risk considerations and our current assessment of risk across real estate markets.

Risk-based approach

Based on our extensive research, and our work with institutional investors globally, we share our recommendations for how institutions can optimize their ability to harness the income-generating potential of alternatives by using a risk factor-based approach to portfolio construction.
About the authors

Additional asset allocation insights

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Explore a range of views across public and private asset classes for short and long-term challenges faced by institutions.
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The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example.

Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.

Please note that this information should not replace a client’s consultation with a professional advisor regarding their tax situation. Nuveen is not a tax advisor. Clients should consult their professional advisors before making any tax or investment decisions.
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This material is provided for informational or educational purposes only and does not constitute a solicitation of any securities in any jurisdiction in which such solicitation is unlawful or to any person to whom it is unlawful. Moreover, it neither constitutes an offer to enter into an investment agreement with the recipient of this document nor an invitation to respond to it by making an offer to enter into an investment agreement.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. Moreover, certain historical performance information of other investment vehicles or composite accounts managed by Nuveen may be included in this material and such performance information is presented by way of example only. No representation is made that the performance presented will be achieved, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Nuveen to be reliable, and not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Company name is only for explanatory purposes and does not constitute as investment advice and is subject to change. Any investments named within this material may not necessarily be held in any funds/accounts managed by Nuveen. Reliance upon information in this material is at the sole discretion of the reader. Views of the author may not necessarily reflect the view s of Nuveen as a whole or any part thereof.

Past performance is not a guide to future performance. Investment involves risk, including loss of principal. The value of investments and the income from them can fall as well as rise and is not guaranteed. Changes in the rates of exchange between currencies may cause the value of investments to fluctuate.