Alternative Investments

Improving portfolio performance

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.

How are investors adjusting their allocation to alternatives, and what are the results?

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.

Exhibit 2: Alternatives allocations by sample investors

Type

Type

Public pension plans

Public pension plans

Sovereign Wealth Fund

Sovereign Wealth Fund

University endowment

University endowment

Global family office

Global family office

Type

Entity

Public pension plans

CalPERS

Sovereign Wealth Fund

GIC (Singapore)

University endowment

Yale University

Global family office

121 surveyed

Type

Size (in billions USD)

Public pension plans

355.8

Sovereign Wealth Fund

>100

University endowment

30

Global family office

1.6  (average)

Type

Date

Public pension plans

March 2020

Sovereign Wealth Fund

March 2020

University endowment

June 2019

Global family office

May 2020

Type

Allocation (%)

Public pension plans

-

Sovereign Wealth Fund

-

University endowment

-

Global family office

-

Type

Equities

Public pension plans

49

Sovereign Wealth Fund

30

University endowment

17

Global family office

29

Type

Fixed income & Cash

Public pension plans

31

Sovereign Wealth Fund

50

University endowment

7

Global family office

30

Type

Other

Public pension plans

-

Sovereign Wealth Fund

-

University endowment

-

Global family office

6

Type

Alternatives

Public pension plans

-

Sovereign Wealth Fund

-

University endowment

-

Global family office

-

Type

Private equity

Public pension plans

8

Sovereign Wealth Fund

13

University endowment

38

Global family office

16

Type

Infrastructure

Public pension plans

-

Sovereign Wealth Fund

-

University endowment

-

Global family office

-

Type

Real estate/real assets

Public pension plans

13

Sovereign Wealth Fund

7

University endowment

10

Global family office

14

Type

Natural resources

Public pension plans

-

Sovereign Wealth Fund

-

University endowment

6

Global family office

-

Type

Hedge funds

Public pension plans

-

Sovereign Wealth Fund

-

University endowment

23

Global family office

5

Type

Commodities

Public pension plans

-

Sovereign Wealth Fund

-

University endowment

-

Global family office

-

Type

Alternatives as % of portfolio

Public pension plans

21

Sovereign Wealth Fund

20

University endowment

77

Global family office

35

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.

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