Alternative Investments

The last 30 years have seen a steady growth and acceptance of alternative asset classes in institutional portfolios as investors seek diversified sources of income and return. These asset classes are sometimes called illiquid or private asset classes because one important characteristic is that they are not publicly listed in markets or no active dealer market exists. Past success of these asset classes, continuous innovation, and the ongoing low interest rate environment are the main drivers of this growth.

One characteristic of alternatives is that these assets classes are far more difficult to implement than traditional assets. Except for commodities, there are no low-cost index funds. They require higher levels of oversight and management than those offered in the public markets. Additionally, due to the closed-end nature of many of the investments, continuous search costs are necessary, thus requiring either sophisticated staffs to build and maintain these portfolios or high out-sourcing costs. Hedge funds require a high degree of active management both at the fund level and the total portfolio level.

The most aggressive users are US university endowments, some with allocations as high as 60%. Yale University started this trend in the 1980s and is now over 75% invested in alternatives. It is the norm to see 40% to 60% allocations to alternatives in large endowments. Global family offices allocated an average 37% to a variety of alternatives according to a recent survey. Mega funds like large public pension plans and sovereign wealth funds typically allocate 15% to 25% to alternatives and are considering increasing their alternatives allocation.

Meeting return objectives in an environment where expected returns across publicly-traded risk assets are lower bolsters the appeal of expanding the investment horizon through the use of alternatives. Alternative Investments: Improving portfolio performance provides a comprehensive overview of the different asset classes investors can integrate into their portfolios more broadly – private equity, hedge funds, real estate, infrastructure, and commodities – and how to do so. We believe investors that add exposure to alternatives under the guidance of sophisticated managers will be able to improve the risk/reward profile of their portfolios through superior returns and diversification benefits.

Meeting return objectives in an environment where expected returns across publicly-traded risk assets are lower bolsters the appeal of expanding the investment horizon through the use of alternatives. This paper provides a comprehensive overview of the different asset classes investors can integrate into their portfolios more broadly – private equity, hedge funds, real estate, infrastructure, and commodities – and how to do so. We believe investors that add exposure to alternatives under the guidance of sophisticated managers will be able to improve the risk/reward profile of their portfolios through superior returns and diversification benefits.