Global Alternative Investments - An Analysis

By M. Isi Eromosele

For the past decade, institutional investor interest in “alternative” asset classes has grown significantly. Such alternative assets cover a wide range of investment opportunities. The major categories include real estate, private equity, hedge funds, and more recently, infrastructure.

An investment is considered “alternative” if it has relatively limited investment history, is relatively uncommon in investment portfolios, is relatively illiquid, has different performance characteristics than traditional assets, is rarely traded in public markets and requires specialized skills on the part of the investment manager.

By contrast, traditional investments have historically been comprised of stocks, bonds and cash equivalents, are traded in public markets, can be benchmarked and are managed by strategies that are not based on short selling, excess leverage, or the use of derivatives.

Interest in alternative assets has gained increasing momentum over the past decade years in particular. The tanking of the equity markets in 2000 combined with the low yield bond environment has led investors to shift a significant portion of their assets out of traditional investments, public equity and bonds, into alternatives.

Pension fund dollars accounted for the largest share of these in-flows. Moving forward, Oseme Finance concludes that alternatives will constitute an increasing share of new allocations by institutional investors, including foundations and endowments, corporate and public pension funds, and high net worth individuals.

Institutional investors now demand alternative and diversified sources of return that are less volatile, yet higher on a risk adjusted basis. Investors are also targeting assets that are uncorrelated with traditional equity and bond investments in order to prevent the severe capital losses they sustained earlier this decade. Alternative investments have come to satisfy both requirements.

Empirical evidence on return performance of alternatives verifies certain key characteristics including:

Additional Diversification

Alternative assets have different return characteristics than traditional asset classes. Their returns are uncorrelated with traditional equity and fixed income, mitigating undue portfolio risk. The level of correlation, however, will depend on the specific type of alternative investment considered.

Potential For Higher Returns

Alternative investments have the potential to offer investors higher returns. Such higher returns, however, are compensating investors for a higher degree of illiquidity and less transparency surrounding alternative investments.

 Longer-Term Horizons

Alternative investments are relatively illiquid, typically with lock-up investment periods. Institutional investors are required to take a longer-term view when investing in alternatives relative to the more liquid traditional assets.

Long-term investors such as pension funds do not require liquidity, however, and can benefit from the “liquidity risk premium”. With plan sponsor’s increasing emphasis on long-duration liabilities (and liability driven investments, LDIs), investors can actually earn superior returns by investing in relatively illiquid alternative assets.

Capital Preservation In Volatile Markets

A unique feature of alternative assets, hedge funds in particular, is the ability to use a number of trading strategies, such as short-selling and the use of derivatives. These strategies are rarely used in traditional, long-only investments, but have the benefit of producing positive returns regardless of the direction of the market. The ability to execute these strategies, however, depends critically on the manager’s skill.

Over time, alternative investments will continue to gain increasing prominence in institutional portfolios. Returns from traditional asset classes, bonds and equity will not be as compelling over the next decade.

This expectation, combined with increasing investor sophistication, has seen investment in alternative assets become one of the fastest growing trends in the global investment arena.

These perceived advantages and the lackluster outlook for traditional assets have rendered the broad alternative asset class as highly desirable. Investors, however, have to accept some hurdles including illiquidity, irregular and lumpy returns, higher fees,and the lack of appropriate benchmarks.

In addition, for many alternative investments, it is difficult to measure risk because there is no market to provide period by period valuations, as in the case for publicly traded assets.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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