Transcription
Welcome to Alternative Realities, a podcast about the people, strategies, and stories driving the world of alternative investments. I'm Aaron Mulvihill, and today I'm excited to welcome my two colleagues and friends, Aaron Hussein and Kerry Craig, back on the podcast to discuss what's going on in alternatives across the world.
Both Aaron and Kerry are Global Market Strategists and my colleagues on the Market Insights team for J.P. Morgan Asset Management. Aaron is based in London, and Kerry is based in Melbourne, Australia. Given all the headlines in the news right now about geopolitics, the global economy, and private markets, we thought it would be a good idea to give listeners perspectives on each of these from a global lens.
On today's episode, we'll discuss some of the top questions we've been getting from clients on topics including energy, infrastructure developments, impacts to shipping, and concerns around private credit. There are no shortage of headlines to touch on right now, but let's start first with the situation in the Middle East.
Kerry, one of the areas you spend a lot of time on is shipping, and it's something that's very important to the economies in Asia. We've obviously had disruption in the Arabian Gulf, but how has shipping been faring more broadly?
I mean, it's a great question. We're looking obviously mostly at the economic impact of what we're seeing from the disruption of energy flows across Asia. Given that it can have quite a diverse impact. We think about, you know, big countries like, you know, China, Japan, South Korea, big energy importers, in absolute terms. A little bit varied when you think about that energy impact as a share of their economy. China, for example, very much smaller. And then thinking about some of the exporters, Malaysia, Australia, how are they still going to demand for the energy exports from those markets to the rest of the world, particularly around the region as well?
So in some regards, you know, as we know, shipping, a little bit like the water that it flows on, you plug up one area and suddenly it moves around. Reminds me of being a kid when you try and dam up a stream and the water just goes around the outside. So it is a case of thinking about the knock-on impacts around this, how it may impact energy flows around the region, but not necessarily shut them down.
And I think the second big thing, when we think about what's happening in terms of that outlook for the region when it comes to shipping and what this may mean, is really you've got this massive, positive impact coming from this AI supply chain story. So, you know, you've all seen the headlines, this $660 billion being spent on CapEx by the hyperscalers out of the U.S. A little bit of a half of that goes into the AI supply chain across Asia. Now develops those semiconductor chips. We think about what's happening in Taiwan. It's memory coming out of, Korea. It is thinking about things like, that manufacturing process, the Q&A that happens around the SAM market, and the fact that there is going to be a still a huge amount of demand for that based on that very strong AI secular theme. And so that is going to sort of support the trade and shipping that comes out of the region. And again, it flows back into thinking about some of these other longer-term shifts. We've seen that again, support the outlook for transport across the region.
One of those being the impact of tariffs and what we've seen, as well as the sort of fragmentation of the global economy. And we've seen that greater linkage between interregional trade come through in Asia, and flows into Europe and away from the U.S. So I know we've got that great chart and the Guide to Alternatives, that map that shows the flows of trade year-to-date across different parts of the world. You can see that inter-regional Asian trade is up about 5.5% year-to-date compared to a year ago, into Europe, from Asia, it's about 9% compared to a year ago. And then into the U.S., it's down about 3% compared to a year ago. So that shipping routes, changing that, that movement within the region becoming much more dominant, as you've seen, that shift from countries going from a China plus one strategy in terms of that corporate view on where they want to resource their imports from, to being something is much more regional and focused. And that supply chain spread across the region is actually having that bit of (Unclear) trade and also on shipping for that reason. So I think there's still a strong case for thinking about how this asset class is evolving, given that fragmented outlook around the world. And again, when it comes to that energy outlook, how Asia may be a little bit differently impacted given we have that blend of both exporters and importers, and certainly that demand that comes through on both the oil and gas side, but also a couple of local players in terms of supply of that as well.
And staying on that, that energy theme, Aaron, in Europe, this latest conflict has reminded us of how vulnerable Europe is to energy disruption and reliant on imports. What are the conversations like there?
Yeah, I mean, that's right, Europe is where the macro consequences of an energy shock tend to be most pronounced. As you, as you just mentioned, Europe imports essentially all of its oil and a large part of its LNG, its liquefied natural gas. So any energy shock tends to have implications for inflation and for growth. And that's, of course, what clients want to have conversations with us about today. And of course, many are trying to draw parallels with what happened in 2022, when we obviously saw Russia invade Ukraine and we saw a very pronounced energy shock as a result of that.
I think there are a couple of reasons we think this is different from 2022. First, when Russia invaded Ukraine, causing the energy shock that we saw in 2022, of course, inflation in Europe was also was already very high and rising. Today it's much lower. It's much closer—
We were just coming out of COVID—
Exactly. We had the post-COVID pent-up demand. We had inflation that was already significantly above target. And then when the Russian invasion of Ukraine happened, we saw, you know, much more pronounced impact on inflation. Today, that inflation rate in Europe is much lower. Second, I think as of today, the increase in gas and oil prices will certainly have an impact on on inflation and on growth, but the magnitude of the increase pales in comparison to what we saw during that period. Also, I think the likelihood of second-round effects, what we economists call second-round effects. So an increase in prices causing labor to demand higher wages, which then results in firms raising their prices again, is much more limited today than it was in 2022, because labor markets on the whole are weaker and we've already seen a great deal of real wage catch-up. So I think the likelihood of those second-round effects is less pronounced this time around.
But I think it's still important to acknowledge that if we take a step back, we have been saying for a while that we think we're moving into a world where we're going to see more inflation shocks, more cost shocks. And as we've been saying for a while, we think alternatives have an important role to play in protecting us from that, from that inflation risk. So I think we're still doubling down on that message that we need bonds in the portfolio to protect us from recession risk, but we need alternative assets in the portfolio to protect us from inflation risks, because they're the asset classes that performed well during that 2022 period.
Yeah, I think we've seen that as well in the U.S. Just looking at the numbers yesterday, the S&P is down and but also a 60/40 stock/bond portfolio is down year-to-date. So bonds are certainly providing some protection against the recession as you said. But when we have inflation as the focus, that can be they can be less effective in zigging while, while stocks are zagging.
Absolutely. And Kerry, turning to you again, in terms of positioning alternatives with clients today, with all these issues in the background, how are you approaching that?
Yeah, I mean, exactly as Aaron just outlined, I mean, there's that harkening back to 2022 and, you know, what is the most horrible word when it comes to thinking about asset allocation and portfolio construction, that's stagflation. You don't want this environment where you're contemplating a weaker outlook for equities because growth's not great or thinking about, the evils of inflation when it comes to thinking about the outlook for yields going up and bonds failing to offer that protection. So there is this view around that stagflation. I would stress that's not our base case within the Market Insights team. We're thinking about, you know, inflation. That could be a bit higher for a little bit longer, but eventually coming down and not being something that does sort of manifest itself into a prolonged stationary environment. But it's just reinforced that role of having the appropriate diversification in a portfolio and how much that does lean into alternatives, moreover.
So we covered this quite extensively, and our LTCMA, or Long-Term Capital Market Assumptions, last year about the role that alternatives play in a portfolio to exactly that, offset some of those concerns around the diversification benefit that comes from owning both stocks and bonds. And so when we have these conversations with clients now, it naturally leans you towards thinking around real assets. So it's transportation assets, it's infrastructure. It's real estate to a degree. It's things that offer that inflationary posture to it. So that, you know, often offset that. But it's more often assets that don't have that strong correlation with the economy because they're essential in, in nature or it's assets, you know, going to has, to have an overall proven, low correlation to those other assets in a portfolio that really offer that diversification. So I think most of the time now, the conversations are really about that. What if we get another repeat of 2022, rather than we're going to see that the investors are more inclined to want to lean towards those assets in their portfolio to try and hedge off some of that uncertainty that may come through. And so that does where we see the real assets.
I think more near-term, when it comes to some of the volatility that we're seeing in the markets. Now, naturally there's a role for hedge funds in that environment. So we've seen that environment in the last few years be challenged. But given that we've had either very low rates and that really detracts from the ability to think about hedge funds that hold cash for collateral (Unclear). Well, we've had, a lot of things going in the same direction. So dispersion within the market has been quite low. And then obviously that translates into also thinking about the valuation dispersion that's been absent from the market. And so those things are coming back. You know, we're having conversations now about how much the, you know, Federal Reserve and other central banks may be cutting rates in this environment. So it could be interest rates a little bit higher for a little bit longer, keeping those cash rates up, helping that baseline for the hedge funds. We're seeing obviously a lot more dispersion in the market in terms of both returns and valuation, and hedge funds being the most active of active managers can take advantage of that. And so there are strategies out there that if you look at how they're positioned, are not going to be correlated with stocks and bonds. Again, we can look at that double chart and the Guide to Alternatives that you have there. The hedge funds, the position relative to a 60/40 portfolio, you know, they're pretty much uncorrelated. And then if you dive into the strategies, things like macro relative value, you know, they're the ones that you want to focus on in this kind of environment. And if we do get through the other side of this conflict, we start thinking about that improvement and, how the markets will be behaving once we have, you know, valuations that have come down and potential upside in markets, some of these more directional strategies may start to come through. So the uncorrelated strategies across hedge funds are a pretty appealing for many at the moment. But I think we already had what was quite a good setup for thinking about hedge funds, their role in that portfolio of that diversification already. So it's definitely a few options there for for investors. We think about how we bring that diversification and how we maybe build in a little bit more income inflation protection or even think about a little more upside, an alpha of some of those hedge fund strategies.
Yeah, I think that's really helpful because again, not, not our our base case that we're in a stagflation or environment or heading into one. But we do get these questions and there are clients that, that have had the view that we might enter an environment like this, and they want to reposition. For us, turning to another area that's been getting a lot of attention in the news, let's talk about private credit. Aaron, how are you speaking with clients about risks in private credit?
Yeah, sure. I mean, private credit is definitely in the limelight at the moment. We've had a slew of negative press starting in Q4 of last year with some instances of fraud. And then more recently in Q1, we saw the failed merger of a couple of funds listed and unlisted, and a few idiosyncratic write-downs of loans in exposed sectors that were hurt by tariffs, such as autos and, of course, some write-downs of some software loans. So there's been a slew of of negative press, which has obviously weighed on on the asset class. But I think it's really important just to separate some of those negative headlines from the fundamentals of the asset class today. And actually, when you look at private credit fundamentals today, they actually look okay. I mean, yields are just over 9% on U.S. senior secured direct lending. They've come down from over 12% in the middle of 2023. So they're certainly less attractive than they were a few years ago. But they're still 160 basis points higher than leveraged loans and around 280 basis points higher than high yield. So there is still a decent bit of yield pickup to be had in, in private credit versus other, other loans and public credit markets. And when you look at the fundamentals, I mean, they're not, they're not bad. Default rates ticked up in the most recent quarter, but they're around 2.5%. That's low relative to historical averages. We've seen non-accruals running at about 2%, which is also in line with historical averages. We haven't seen a material pickup in leverage. And when we look at broader measures of distress, what we would call selective defaults, they definitely picked up post 2022. And we saw rates rise. But even there, things like liability management exercises or payment-in-kind income have stabilized over the last couple of quarters. So on the whole, the fundamentals don't look that bad.
But as you said, there are concerns around AI and software disruption, and they are real risks. If you look at private credit, it's heavily exposed to tech. About 40 to 45% of aggregate deal value is in tech and about 20% exposure to software. So those risks are real. But in our view, they are micro risks rather than macro risks. And there are ways to mitigate some of these risks when allocating to private credit. So we would advocate for trying to diversify across managers where you can, to diversify across vintages, where you can, to try and minimize some of the concentration risk that you would get by being heavily exposed to one vintage or one manager that may be heavily exposed to just particular sectors. I think it's also worth looking more broadly. When we talk about private credit, we're typically talking about direct lending. But of course, there are other subsectors and sub-asset classes within private credit. So thinking about asset-backed finance, I think there's still opportunities there in infrastructure debt, for example. Or commercial real estate debt. And also thinking about distressed debt in special situations. Those sorts of parts of the market tend to benefit if we do see defaults pick up more than, than, than they are at the moment.
Yeah. I think you're, you're absolutely right in terms of the the fundamentals versus perception. I was at an institutional investors conference last week, and they did a live poll where people voted on their phones and they asked, what's your appetite to continue to commit to private credit? And 56% of the room were trying to increase commitments, 33% were were planning to stay sort of neutral in terms of their allocations. And I think it was 7%, I don't know, from 80 up to 100 here or not, but let's say about 7% was, were planning to to decrease commitments. And those numbers aren't far off from some of the survey numbers we have in the, to alternatives that indicate broadly, appetite to continue to increase allocations. But I think selectivity is is absolutely critical. Right now and and being conscious of of the types of funds and, and assets that, that, that are being acquired, if you have a view and software, then, take that view in terms of the selection of funds.
Moving to to another area that's been topical recently. Kerry, we've seen a lot of press around elevated requests for redemptions in semi-liquid funds. What's your take on this, and should investors be concerned?
Yeah, I mean, it comes back to a lot of what Aaron just discovered around this idea of paying, tweaking the perception of what's happening versus the fundamentals of what these asset classes actually have. This may be hyperbole, but, you know, there's nothing to fear except fear itself, is, kind of, like how I would summarize it. So the more that people read these headlines, the more they get concerned there's something happening. You know, the more money they want to pull out of these funds because of that perception that they maybe won't be able to get their money back in the future or their investment because, you know, these, they're the difference between, the liquidity of the investor and the liquidity of the underlying asset. So as you think about people allocating these funds, you know, they are semi-liquid that does give them or afford them the opportunity to invest in an asset class that perhaps a few years ago wasn't available to them because they were very much illiquid. And so you get the benefit of having that. But it does come with some of these restrictions sometimes that are, you know, they're designed to protect the funds. So these headlines about funds being gated, about limiting the withdrawals that come through and the access to that money, that's not necessarily saying that, you know, the investor can't get that money back in the future. It's just that they need to manage the quality of the underlying assets. And those are usually very well-known and well-described things an investor agrees to before they move into the funds, that they do have these netting clauses that say, you know, typically on a semi-liquid product that has quarterly redemptions, you can apply to get your investment out every quarter. There's redemptions as sort of capped or limited, around about 5% of the NAV. Overall, there's some flexibility in that depending on the product. But, you know, that's the rationale for protecting those investors who remain in the funds to prevent the for sale of assets at a, at a heavy loss that may inflict pain on other investors. So I think that's the nature of ensuring that the semi-liquid nature is intact and that they can have access to these things, notwithstanding that they, you know, may not be able to remove their full investment at any given time if there is this concern that comes through.
But again, it's that point Aaron made about the perception versus, you know, the underlying. And I'm sure that, you know, perhaps not being a little bit more mindful of some of the risks and some of the commentary out there. It's a, it's a bit like the peeling back the layers of an onion. So they want to see where those risks lie. And there is some indicator there's a bit more stress in the market. There is some crack starting to appear, but it doesn't mean the middle of the onions rotten. It just means that investors have to be a little bit more, doing more due diligence, a little bit more careful about the managers they're looking at or, as Aaron outlined, being more diverse across the different strategies and different managers they want to allocate. So in that regard, so I think this is the nature of an asset class which has grown very quickly, has been very attractive for the (Unclear) yield. That was an offer at a time when other parts of the public market didn't look as attractive. I think probably naturally you've seen a little bit of reallocation in terms of portfolios. Now, we've seen a lot this year taking profit on things that have done very well. Looking to balance out that portfolio a little bit more. Some of that may have crept into the private credit market, as we've seen spreads compress down a little bit. Yeah. But overall this is a very viable way to think about having an income generated in your portfolio. And it's going to be a very, persistent area of investment in the economy that drives the economy forward. So it's not something we expect to suddenly stop happening in terms of that private lending coming through. But I think it's just a sign of a maturing asset class. We do see these things about some of these risks, some of that transparency or limits of transparency coming to the fore around what the underlying metrics you really need to look at to assess that quality. And that just means being a little bit more diligent about how you allocate to this asset class. So I think there's probably, you know, to be honest, probably gonna be some more headlines that still come out around these things. There's been some pretty punchy ones, those (Unclear) that we've seen on some of these products. The limit to the withdrawals is not necessarily a bad thing, though. It's just more about liquidity management than thinking about the potential underlying issues in a fund which, you know, don't appear to be there. So I think that's an eyes-wide-open scenario for investors who are going into these types of products and understanding what semi-liquid really actually does mean.
Yeah. And the education is so important, with the slide we added last year to the principles of alternatives that's used by financial advisors here in the U.S. And there's a a section there on different types of funds. So integral of funds and tender offer funds. And it asks the question: can it be gated. And for every single one of those funds it says yes, yes, yes, yes, yes. So it's important to make that very clear that yes, funds can be gated. That's generally to protect the interests of investors. But how many individual investors is going to read the fine print? So we have to make that fine print a little bit bigger sometimes to make sure that's clear that it's a, it's intended to be a long-term asset class and, and designed to, to be effective that way. I mean on the, the AI and software point, it's clear there are going to be winners and losers in that space. I don't think it's right to tarnish all of the loans with the same brush. I mean, not all software and software as a service is the same. I think one thing we should stress is that dispersion is going to widen through this cycle. The best performer, the gap between the best and worst performing managers is going to widen. We make this point a lot across most of the alternative asset classes that manager dispersion is wide relative to public markets. And I think in private credit it's going to widen through this cycle. So I think manager selection is going to be way more important than it was ten years ago. In this asset class.
Yeah. Couldn't agree more. We'll wrap up with a question for both of you. What's one trend in alternatives that you're continuing to keep a close eye on for the remainder of 2026? And I'll give you one that I've been thinking about, which is defense, technology, and venture capital since the start of the Ukraine war. There's just been a tremendous amount of innovation on the battlefield in Ukraine. And we're starting to see drone technologies deployed across the world now. And that's ignited some interest in venture capital, which is an area that hasn't really explored defense. It's been sort of perceived as, as, as a relatively niche industry and venture has gone towards software and technology and so on. And now it's embracing the hardware of, of defense technologies. That's what I'm, I'm quite closely interested in. It's not quite gone mainstream. Yes. But there's a lot of exciting things going on there. How about you guys? What do you, what are you keeping an eye on for the rest of the year?
I think mine's probably, probably less exciting. I mean, like, venture capital always seems like the most exciting part of when we talk about private markets and all the innovation that goes through there. The, one of the things I'm watching more, and it's, it's been overshadowed a little bit. So obviously all the talk has been more recently around the private credit side. But when we're looking at private equity, you know, coming into the year, it was always, like, this is going to be or has the potential to be the massively strong year we saw, you know, activity momentum really pick up through the last quarter of 2025. The expectation was you're going to see a lot more deals happening this year. There was, you know, the right set-up of markets. So we're heading in the right direction. Funding that was still, you know, quite affordable coming through from either the rates outlook or the private credit outlook. And obviously what's been missing for a long time, that space has been, those redistributions back to those investors. And again, in the Guide to Alternatives is a chart that shows you those distribution rates for private equity, even though that activity in those capital core rates has been increasing, those distribution rates were still very, very low. And so they hadn't started to pick up. And I think that's still going to be quite key because these investors are still looking to get their money back or waiting for those monies to come back. And so you're seeing that pick out, pick up in the use of continuation funds. You've ever seen a huge amount of money been going into the secondary market to try and create again that liquidity. There's distributions that have been missing. And so watching that quite closely that we actually do see that relationship come back and we do see that distribution come back through because I think that is going to be something which was, you know, a little bit of a concern for a while and got overshadowed by some more recent events. But I want to focus really on seeing that relationship come back through. And if we do start to see those distributions pick up or not, and then fundamentally why that is just the, the backlog of that deal flow that has to be cleared before we start to see that come through, is that the pricing that really has to adjust to make that more attractive? And again, does that mean we just focus more and more on the secondary market in terms of where we could see, you know, further gains, coming through on the private equity side for investors?
I think what we're clearly going to be keeping a very close eye on: what happens to default rates and measures of distress in private credit. Of course, that's a very hot topic, at least in Q1. Outside of that. And I still think it's really important to monitor what's going on in real estate. We've obviously had two quarters of positive capital appreciation when we look at global private real estate returns. I think the recovery was starting to pick up. If you looked at transaction activity in the U.S., it's starting to pick up. That typically leads Europe. And if we look back historically at these turning points, is typically where it's been best to start deploying capital, is where you see returns that tend to be much higher than, than historical averages. Of course, what happens with the U.S. and Iran and the implications for inflation, and therefore the rates outlook will have a material impact on what happens in real estate throughout the course of the year. But I remain optimistic that we're going to continue to see recovery in the real estate sector through the course of 2026.
Well, this has been great. Aaron, Kerry, thank you very much for coming on Alternative Realities.
Pleasure. Thank you.
That was Kerry Craig and Aaron Hussein, Global Market Strategists for J.P. Morgan Asset Management. To all our viewers and listeners, thank you very much for listening to the Alternate Realities podcast. You can download our first quarter 2026 Guide to Alternatives on the J.P. Morgan Asset Management website at jpmorgan.com/gta. And if you've not already done so, please subscribe to Alternate Realities on your favorite podcasting platform.