Read the article and learn about:
- Alternative assets’ growing importance in diversified portfolios
- Expectations for the future direction of alternative assets in 2018 and beyond
- Alternative assets industry trends – the potential impact on investors, allocators, and the operating platform
Head of Hedge Fund Products, Preqin
About the author
The term ‘alternative investments’ is increasingly something of a misnomer. Four out of five institutional investors globally have some exposure to private capital or hedge funds, and more than half invest in three or more different alternative asset classes. This is a stark shift from 20 years ago, when a considered approach to alternative assets was part of what set investors like the Yale University Endowment apart. Twenty years may be a long time in some asset classes, but it represents just two life-cycles for the typical private equity vehicle – a sign of how quickly this sea-change has occurred. In this article, we take a closer look at the future challenges and opportunities facing investment managers with the growing importance of alternatives assets.
The attraction and complexity of alternative assets
The appeal of alternative assets is slightly different for each investor, but centers around three core advantages of these asset classes. First, they offer portfolio diversification at a time when most traditional asset classes are seeing their long-term trends increasingly converge. Second, many alternative assets investments offer a significant hedge against inflation, particularly among real assets funds. Third, alternative assets offer a strong profile of risk-adjusted returns, even as they are still considered relatively high-risk assets.
It is perhaps this third advantage which has mostly driven investors to engage with the asset class over the past decade. In the wake of the 2008 Global Financial Crisis (GFC) and the ensuing prolonged period of depressed interest rates, institutional investors found that some asset classes such as fixed income investments were not offering them the returns they had done previously. At the same time, increasing liabilities – particularly for pension funds and insurance companies – meant that the gap between required and actual rates of return rose. Alternative assets, meanwhile, were not as severely affected by the GFC as some other asset classes, in part because their illiquid and long-term nature insulated them from sharp shifts in investor sentiment. As such, the relative rate of return offered by alternative investments compared to other asset classes has been attractive to many investors, and allocations to the alternatives industry have surged in the proceeding period.
Beyond pure engagement, we have also seen the extent and complexity of investor allocations to alternative assets increase in recent years. At the start of 2018, 52% of investors are allocating to three or more alternative asset classes. Among these, real estate, private equity, and hedge funds are most commonly sought after, with 59%, 58%, and 50% of institutions respectively committing to these sectors. Even the least sought-after asset class, infrastructure, has more than a third (36%) of institutions globally allocating to it.
Allocations can be significant too: around half of investors active in private equity, hedge funds, or real estate allocate 10% or more of their total assets to these sectors, while a similar proportion allocate at least 5% of assets to private debt, infrastructure, or natural resources. And increasingly, we are seeing investors create specific allocations for each asset class in which they are active, rather than using a general alternatives allocation. This shows the extent to which alternative assets have become a mainstay of investors’ portfolios.
Operational challenges and support
This provides investors with more options to fulfil their long-term investment goals, but brings with it increasing challenges of portfolio monitoring and appraisal. Alternative assets’ illiquid and long-term nature makes it difficult to directly compare the risks and performance of these investments with traditional asset classes. Today, many investors must use hybrid monitoring platforms which rely on a large degree of manual labor and which cannot provide timely analysis. Increasingly, sophisticated multi-asset class solutions for investors are coming onto the market, but most require investors to convince fund managers of the necessity of adopting them – not always a straightforward task. However, with competition increasing, investment managers must strongly consider if they can afford not to transform their operating models and adopt multi-asset class solutions that can handle alternative investments on the same platform as traditional assets.