Institutional investors and consultants are struggling to meet historical returns figures through traditional investments such as equity and fixed income and so have increased their allocations to alternatives. According to a 2016 study from Willis Towers Watson, the percentage of the allocations in a portfolio to alternatives has nearly tripled over the last 20 years, and continues to be an area that clients are looking to diversify into in search of these return objectives.
There are of course many different types of alternative investments. How are consultants and investors thinking about each of the specific options as they work to meet target returns? eVestment held a recent panel discussion with three distinguished members of the institutional investment community.
Joining us were Arno Kitts, CIO of Perspective Investments, who before founding Perspective had a lengthy career in the insurance and asset management area, including acting as the managing director of Blackrock’s UK institutional business; Dan George, CIO of Ellwood Associates who oversees both the traditional and alternative manager research for the firm and who has a particular focus on endowment and foundation clients; and Bryan Mullin, Head of Alternatives for RBC, responsible for advising the firm’s high-net-worth advisors on alternative investing.
Asset Allocation and Target Returns
Panelists noted that it would be very difficult to sustain historical levels of portfolio returns even with alternatives because of the increased competition to find the right assets. “Challenges and risks facing investors with alternatives actually might be quite attractive relative to the challenges and risks investors face with conventional assets,” one panelist noted.
Panelists agreed that managing expectations was key when allocating to hedge funds. “We are not surprised to see cash outflows, at this point we would say that’s probably healthy for those investors remaining in the asset class,” said one panelist.
Another panelist noted a few broad dynamics regarding hedge funds, including an influx of new managers, a decrease in the number of stocks and lower interest rates showing its toll on managers who have used that as a “ballast” in their portfolios.
Panelists were optimistic about the ability for private equity to achieve a return premium over public equities of several percentage points. However, the illiquid nature of private equity investments would require “robust cashflow modeling and vintage year diversification,” one panelist said. Manager selection was brought up as a critical factor. “If you look at the historical data, in order to have above decent returns, you would have had to have picked the top quartile managers. That’s very difficult. It makes the case for databases and information to enable people to hone in on those managers that are more likely to deliver returns going forward.”
Investors are viewing real assets as “something different, something special” that can help diversify a portfolio. Panelists did not necessarily agree on the total allocations for real assets with one recommending no more than 25 percent while another said he had portfolios with more than 50 percent real assets. “We find it extremely attractive. But never to lose diversification,” the panelist said.
Another of the panelists separated out real estate specifically from real assets. “We have dedicated research committed to identifying best-in-class investment managers across a couple different real estate strategies,” the panelist said.
All panelists noted there is a “trend for fees and it’s down.” One panelists encouraged investors to dig deep and truly understand the value they are getting. Panelists agreed that the top managers are able to justify the higher fees. “Overall you get what you pay for. The premium managers are not having to really adjust fees,” one panelist said.
To get a more in-depth look at the role of alternatives in investor portfolios, download our whitepaper, “Trends in Alternative Investments 2017” or watch a replay of the full panel discussion, “Sustaining Portfolio Return Using Alternatives.”