Alternatives: The hunt for diversification

In looking beyond stocks and bonds for diversification, many times access to alternatives limits investors. However, if this limitation can be overcome, investors might consider adding private credit or commercial real estate for greater risk-adjusted returns. Beyond the potential for less correlation to stocks and bonds, there may also be potentially higher returns in exchange for a longer-term commitment of assets.

Why do some options have the potential for less correlation? For private credit, the modern market emerged after the GFC to fill the void banks left as they significantly reduced their lending to small- and medium-sized businesses. We believe emphasis needs to be on selecting top-tier managers, who not only specialize in finding genuine value, but in avoiding accidents—not indexing the category.

Similarly, a different correlation from commercial real estate can come from some automatic adjustment to inflation, as rental rates often align with price increases. While current levels of inflation and the possibility of recession are chal- lenging for real estate investors, segments including industrial warehouses, life science facilities, and multi-family rental properties can provide strong returns as well as a hedge against inflation. In the alternatives section, we provide outlooks for two areas that may help with diversification: infrastructure and commercial real estate.

Think diversification

After a tough 2022, many investors may feel like standing on the sidelines. That sentiment, however understandable, is best avoided. As inflation declines, bond returns will likely recover, as will the potential diversification benefits of holding bonds alongside stocks and select alternatives. While it may be premature to dive into the equity markets, focusing on select themes may deliver better overall portfolio returns in 2023. For specific thoughts on allocations, we direct you to Allocation Views, our quarterly publication from the Franklin Templeton Investment Solutions team, to see how they are approaching 2023. The silver lining from 2022’s difficult markets appears to be an improved potential for long-term returns, and the return of diversification within multi-asset portfolios.

In what follows, our investment teams offer their perspectives and, most importantly, their key investment opportunities for 2023.