The only thing we have to fear is… fear itself.

The first inauguration of Franklin D Roosevelt

Much is being written in 2021 about price inflation, debating its persistent or transient nature, and conveying a general worry over the impact of inflation on asset prices. With this note, we hope to explore the history of inflationary periods to determine how much inflation impacts fundamentals and how much market action is merely fear itself.

Investors with some age on them have been shaped by the period of elevated inflation in the 1970’s. As the graph below shows, most other inflationary periods have been associated with wars — with prices spiking from wartime shortages and then deflating when supply/demand conditions returned to balance. But the inflationary period of 1973-74 was different and not associated with wars but with monetary policy. Stock prices during this period declined by more than 45%, and bonds saw coupon interest undermined by declining principal value from rising rates.

Interestingly, the battle against inflation didn’t actually commence until after the Nixon Administration’s easy money policies had been abandoned and the Volcker Fed commenced a high interest rate regime to “break inflation’s back” in the early 1980’s.

Given the noise in the markets today, one would expect that this would have been a horrific period in which to be an investor. But despite persistent inflation during the ten years following the ’73-‘74 bear market, eight years were positive for equities. Bond returns were positive a similar percentage of the time. And shockingly, S&P500 returns (including dividends) averaged more than 15 percent per year during this decade. It would appear that inflation surprises are more important than inflation itself.

What does one make of this revelation, and how does it relate to private investments?

First, one must admit that market averages hide the volatility that affected many companies and sectors. Those bear market years were most difficult for high multiple growth stocks whose prices often declined by more than 80%. (Remember that Avon Products and Coca Cola were growth stocks of that era.)  Clearly, future earnings are worth far less in a high inflation environment. Similarly, lower quality names with high leverage were also decimated as the rising cost of leverage took its toll on free cash flow and solvency.

In the current era, the private equity industry has thrived in this period of lower cost leverage, allowing managers to widen their view of potential targets and buy at ever higher valuations. Assuming “real” rates of interest behave logically, then higher inflation would raise financing costs and put marginal deals out of reach. We would expect skilled managers to continue to succeed in such an environment, while those without an edge would eventually point their careers elsewhere. Investors without a coherent strategy may find this new paradigm less than accommodating.

The takeaway for private investments, therefore, is not that inflation is scary, or that it is benign. The observation is that low leverage strategies should endure. Skilled managers and sponsors in private equity can continue to add value. Enterprises with pricing power will better be able to navigate whatever environment exists. And certain real estate categories are clearly inflation hedges, with rents that adjust over short time periods. Conversely, highly leveraged strategies and overpaying for growth are risky endeavors when discount rates rise.

At Altera, we strive to identify strategies with real value-added as opposed to “prosperity through financial engineering”. We seek enterprises with pricing flexibility and modest leverage. We favor durable revenue streams, even at the expense of being a little dull. We are long term investors in long duration assets.

We can’t predict inflation rates, or whether or not the current spike will endure or prove to be transitory. But as history has shown (in the graph above), change IS the constant, and inflation rates are just as likely to surprise on the downside as the upside. This makes the entire inflation discussion (for long term investors in private securities, anyway) as much a media-driven phenomenon as it is a fundamental one.

When financial assets are strongly appreciating, diversification (to put it mildly) looks like a Fool’s Game. Speculative assets during such periods can hold unmistakable allure. Whether cryptocurrencies in 2020 or “dot com” stocks in 2000, investors ask, “Why didn’t my advisor diversify my portfolio like that?”

The corollary for investors in alternatives might be, “Why did I invest in this (sleepy) infrastructure fund, or in this yield-focused private credit vehicle?”

Altera recognizes that alternatives are unlikely to be a portfolio’s short-term “star”. It is easy to forget the investment case for, say, that infrastructure fund. That’s not to say that such investments don’t have clear appeal, tending to have a sizable income component and a chance at some appreciation, too. And as an illiquid asset, their value would be expected to change little over any short time period.

But stable income seems dull until markets become volatile. And future appreciation isn’t truly appreciated until it we actually see it.

In 2021, we might welcome a few assets with a lower correlation of returns with the public markets. Volatility has returned, and a vicious tug-of-war is occurring between richly priced growth stocks and the “value” shares that have underperformed since 2008. Some past winners have lost half their value from recent highs.

Meanwhile, today’s investors may be taking more risk, having allowed portfolios to drift to higher equity allocations. It is also well documented that investors’ “home bias” has continued to grow. And portfolio concentrations could possibly be higher than any time in recent memory. Five large cap tech stocks now account for 20% of the S&P500 and may comprise a significant part of many investor portfolios.

The question is this: Can volatility remind us to keep our eyes on the actual prize? Can it help us remember to play the long game of building wealth by compounding attractive long- term returns across a variety of less-correlated assets?

The challenge, of course, is in our basic human nature. Investors look at their portfolios and may not see concentrated risks across securities whose returns are driven by similar factors. Instead, they notice that some alternatives can take years to get fully invested or see the “J-curve” where initial periods show losses, not gains. Diversification requires patience in comparison with a robust market environment — especially when the sequence of returns for “alts” is weighed more to the future and less to the short term.

On the other hand, if those alternative investments can generate equity-like returns without equity market risk, then the long-term investor is the winner with a smoother ride and the returns that they need. Seven years in, that infrastructure investor may have gotten most of his or her capital back. And, by year eight and nine, portfolio exits may be occurring, with lumpy returns that make few headlines, but that can swell account values with little fanfare.

Human nature is unlikely to change, but with the mindset of a business owner, we can see the compounding at work (and not just the excitement of ups and downs) across our portfolio of “businesses”. Or, when we think like a pension fund manager, taking a truly long-term perspective, we can see how a balanced array of diverse return sources can make it more likely that we will achieve our financial goals.

In other words, we can be in tune with the actual workings of our portfolio. If volatility is what eventually gets us to have this mature look at our investments, then that not-so-gentle reminder is valuable indeed.

For many years, the default allocation for a large number of investors has been the “60/40 Portfolio” — an allocation so titled for its 60% portfolio weight in stocks and 40% allocation to bonds.

The conditions that made this allocation work so well, however, are no longer in place. In this article, we outline other options that should help investors to meet their financial goals without taking on large amounts of additional market or credit risk.


The simplicity of this allocation was part of its strength. Over the years, its ability to mitigate volatility without a big reduction in performance made it valuable to investors who wished not to endure the full volatility of the equity markets. To use a badly worded metaphor: One could have their cake and eat it, too.

This attractive mix was possible thanks to two factors that no longer exist: Relatively high interest rates and fair valuations on stocks. A 40-year decline in inflation and interest rates created a wind at the back of both stocks and bonds, pumping up the returns of both. And now, bond yields are in the very low single digits and stock valuations are approaching all-time highs.

What is an investor to do when the wind that was once at one’s back is no longer blowing?

To make the 60/40 work in the current environment, investors need to take on different portfolio exposures and different risks. Low yielding bonds need to be replaced by, or at least supplemented with, higher yielding vehicles. Overvalued stocks need to similarly be paired with more attractively priced choices.

Put simply, investors should look at assets in the private markets. All things equal, private investment valuations should be below those of the equivalent investments in the public markets and yields commensurately higher, as compensation for the lack of trading liquidity.

But what if this lack of liquidity was a benefit, not a drawback? By definition, an asset that is priced monthly, or quarterly, will have less volatility than one whose price updates every second. That does not reduce the chance of principal loss in a private investment, of course, but it does mean that such vehicles in a portfolio could create a smoother ride for the investor.

Both affluent investors and institutions have liquidity needs that need to be carefully monitored. But those same investors likely have a portion of their portfolios that will remain invested for years or even decades to come, with no need for funds to be distributed. Investors who create a budget for illiquid investments can harvest the returns associated with that lack of trading liquidity.


The opportunity in private credit was created, in part, by the increased scrutiny of bank lending activity. Higher capital costs associated with loans to mid-sized firms effectively forced banks into to the larger end of the lending market, creating an opportunity for private lenders to fill the void.

For bond-like investments of similar credit risk, a private credit vehicle will typically post yields higher than those of the public market equivalent. A study by TIAA Global Asset Management found that private loans carried an “illiquidity premium” of 100-200 basis points (1-2%) versus syndicated loans, despite a lower default rate.

Middle market lending has even higher interest rates than one finds in the public or large corporate market, on top of the illiquidity premium. In fact, it is not unusual to find private lending vehicles yielding upwards of 9%. It is also important to note that private loans could be based on floating rates, reducing the interest rate risk of the instrument to the investor should rates rise.

There are many different segments of the private lending market, with varying risk and return characteristics. Investors are wise to carefully consider the characteristics of each one. The bottom line is that this segment is decent place to look for possible portfolio yield enhancement.


The catch-all term of “private equity” is used here to include private investments across a wide array of categories from private real estate to infrastructure to venture capital.

The characteristics of such investments will vary greatly, of course, but a common theme across many of them is higher cash flows to investors versus publicly traded securities. It is not unusual to see private investments with cash flow yields between 5 and 7 percent. In the public equity markets, the S&P500 has a current dividend yield of less than 1.6%.

The attraction to these asset classes has been their historic return premium over listed equities. Cambridge Associates estimated this return premium to be 500bp per year over the 25 years through 2016. Similarly, retirement fund CalPERS (in the graphic below) showed a 500bp return advantage for their private equity investments over their public ones over a 20-year period.

Investors are cautioned that averages can be deceiving. The so-called “vintage year” of a private fund is among the most important factors in determining whether a particular fund does better or worse than the average. Years following recessions have typically been among the better vintages for both venture and private equity funds.

Niche-focused lower and middle market strategies often overlooked by large, mainstream investors and purveyors of mega-sized private funds. These strategies are difficult to execute at a $1bn scale. And they often rely more on micro-level strategy execution than macro-level valuation upgrades. Their “alpha”, therefore, is dependent on different drivers than those that impact the broader market, making them potentially better portfolio diversifiers.


Investors can draw conclusions from the relative success of other investors who have walked a similar path. Cambridge Associates tracks hundreds of institutional investors with varying allocations to alternatives. Their simple conclusion (in the chart below) was that the most successful of these investors were the ones who allocate more than 15% to alternative investments, averaging more than a 1.8% return advantage over those who allocate just 5%.

In the current environment of low interest rates and richly valued stocks, these lessons can be liberally applied to the 60/40 portfolio. Individual investors and small institutions have the added benefit of being able to execute niche alternative strategies to potentially enhance their long-term returns.