Keith Black of CAIA discuses recent trends and developments in allocations to alternative investments in today’s market environment.
Date: Nov 2011
When looking at the endowment model of the largest US universities, for example, which had invested between 40 and 60 percent of their assets in alternatives, he said their concerns were related to a shortage of liquidity.
With a mature private equity or real estate programme, for example, where the investment is in a 10-year closed-end fund, the commitments into the funds are drawn down over the initial two- to four-year period, with the expectation that in the latter half of the 10 year-period investors will receive the distribution of the capital.
But in 2008, Black said investors saw that it was difficult to get liquidity from some of their other holdings to fund new commitments to private equity and real estate. At the same time, it became difficult to sell these funds, or to have an exit event in a venture capital fund, which in turn slowed down distributions as well.
Tackling allocation challenges
In response to these developments, Black said university endowments are holding more cash as a portion of their asset allocation, rather than having a negative cash position or a leveraged portfolio.
Popular strategies for volatile markets
According to Black, options and volatility strategies are becoming more popular. For example, the strategy which most benefited from 2008 was managed futures, he explained, with very large positive returns on managed futures funds in the second half of 2008.
The ability to make a profit in a liquid investment during that type of market environment is very attractive to investors, he said.
Further, as some investors were scrambling for liquidity, they were able to cash-out of their managed futures positions and either enhance liquidity of their fund or take advantage of some certain opportunities.
Changing approach to due diligence
Investors have become significantly more involved in the due diligence process, said Black, with this being much stricter than before 2008.
These has been an increasing focus on managed accounts, exchange-traded products, and the external verification of the administrator and net asset value.
Deeper due diligence is also being done on managers, added Black, explaining that this means visiting them and checking whether the returns to their strategy are correlated to the returns from other managers using the same strategy, as well as verifying balances at banks to make sure the trading is actually happening.
Hedge fund trends
According to Black, the hedge fund industry is becoming more and more institutionalised, resulting in a larger and larger portion of capital being placed with the larger managers.
The scale needed to compete as an institutional hedge fund is therefore growing significantly, he said. The minimum amount of assets needed to get involved in the institutional space has now risen from around US$50 million or US$100 million to between US$100 million and US$300 million – based on the need to invest in a dedicated risk manager, a great management system and an external administrator, as well ensure all of the transparency now required.
This is making it more difficult for fund start-ups to launch, and for small funds to compete for new assets in the institutional space.