With depressed interest rates for the foreseeable future and expanding equity valuations, investors should turn to alternatives to improve portfolio performance.

The low expected returns in public markets, cash rates near zero or negative for most countries, and the long end of many yield curves still near historic lows are tailwinds for alternative investments, such as hedge funds, real estate and private equity.

The attractiveness of alternatives is their potential to improve investors’ return/risk profile. Hedge funds and real estate offer the ability to diversify and lower portfolio risk for the same level of return offered by public markets. Private equity, meanwhile, offers the ability to improve return.

UBS Asset Management’s latest five-year capital market assumptions shows that investors need to blend traditional and alternative asset classes into a strategic asset allocation to meet their targets going forward.

Below are some of the key takeaways for expected returns into 2025:

Equities

o    The rapid run up in equities in the last few months have erased some of the premiums we expected in our May report. On an absolute basis, we view the market as slightly over-valued (especially the US).

o    We expect a global equity portfolio to return 6.5% in unhedged USD terms over the next five years. 

Fixed income

o    Overall, the return to government bonds since our last report is about the same: -0.2% (hedged USD terms), slightly lower than the -0.1% in May.

o    The expected return to a global credit portfolio is 0.2% in hedged USD terms.

o    The expected return for high yield bonds declined to 1.8% from the 4.1% in late spring.

Hedge funds

o    With low interest rates and low credit spreads across the world, the costs of borrowing are extremely low. This leverages the alpha opportunity set for all sorts of hedge fund strategies – long-short, market neutral and macro, for example – and previously unprofitable trades now look attractive.

o    Another boost for hedge funds will be greater dispersion of returns, which will benefit strategies like equity long/short and relative value. Additional tailwinds are fits of volatility and regime changes.

Real estate

o    We expect real estate returns to wobble for another quarter or two before rebounding to 5% to 6% net returns for investors in core funds. More aggressive investors should see returns approaching those of global equities – 7.2%. Note that these returns are well above estimates for bonds and cash.

Private equity

o    We expect a global private equity portfolio to provide returns 2% to 3% above the public markets. This is not a pure premium, but a fair compensation for the overall economic and liquidity risks taken.

o    For investors with very long time horizons (25+ years), a dedicated portfolio to private equity should help performance.

o    The secondary markets are getting deeper, offering liquidity in both building a portfolio as well as winding one down. Consequently, time horizons for viable private equity portfolios could be as short as 10 years or 15 years.