By Ingo Heinen, managing director and member of the Alternative Investment Strategy Group within Blackrock Alternative Investors
As investors adapt to the new world of investing – one defined by high correlation among asset classes, high economic and geopolitical uncertainty, and low yields – most have concluded that they need novel ideas and new approaches to achieve desired outcomes. Given this reality, it’s no surprise that investors are recognising that alternative investments can be an invaluable tool to enhance returns, increase diversification, and reduce overall risk.
This change hasn’t happened overnight but, as investors review mandates and update plan policies, the trend to greater allocations to alternative investments looks set to continue. The increased adoption of alternatives is being driven by an expectation that the market factors challenging investors over the past few years will remain in place for the foreseeable future. But as investors embrace alternatives, they require more transparency, greater alignment of interests, advanced risk management approaches and appropriate liquidity structures. Not surprisingly, the alternatives industry is being forced to evolve. There has, for example, been considerable consolidation, with most of the fund flows over the last few years going to the most established managers. Greater consolidation is expected over the coming years, with regulatory dynamics set to add to this trend and likely to serve to reduce the number of providers. In a quest for the holy grail of high-returning products with low correlations, many institutions are finding themselves investing in asset classes and strategies that include natural catastrophe risk, agriculture, mining and metals, or truly market-neutral hedge funds that seek to deliver alpha from less conventional sources. But in an environment where every basis point matters, many investors do question whether hedge fund, private equity and real estate managers are worth the fees. Many investors understand that the complexity of the asset classes can come at a premium. They also understand that simply looking at fee levels without looking at the results will reduce their options and the potential outcomes, and they know the importance of focusing on what a manager delivers when evaluating fees. The wide performance dispersion of alternative strategies highlights the need to identify above-average manager skill. Investors must address a broad array of organisational, operational, and investment criteria before making any hiring decision. In addition, one of the most critical success factors (especially for hedge fund investors) also seems like the most rudimentary: knowing when to sell. In order to succeed over the longer term, it will be imperative for investors to step away from the narrow mind-set of historical asset class definitions and instead consider alternative strategies in terms of their risk factors. It is important to recognise the permeating nature of exposures, understand them, budget for them, and allocate them to areas of the investment universe that deliver the greatest unit of alpha per unit of risk. It is helpful for an investor to first set a framework that assigns a total risk budget and then identify the beta and alpha contributions of each investment type. Of course, there are other factors that are extremely important, including liquidity parameters. The future demands thinking less about a singular “alternatives” silo and instead decomposing the risks in these investments and translating them into traditional risk factors. With a better understanding of how alternative investments interplay with the rest of a portfolio, investors will be able to more efficiently integrate them in a riskaware fashion.
Comments