Follow the Money?

We often wonder whether certain articles and authors are purposely taking a shot at “Alternative Investments,” or whether they just aren’t seeing the bigger picture or just missing some important details.

The latest article that piqued our interest was titled “Follow the Money,” by RobertSeawright on his blog Above the Market. This article had a bit of a different take for a refreshing change, saying essentially don’t go into alternatives because that’s what every other investor seems to be doing right now, and if you ‘follow the money’, they are doing it not because its good for them, but because its good for Wall Street.

But beyond the asset flow take, it’s mostly the same old song and dance, with claims that Alternatives don’t have good performance and that the fees are too high. We’ve covered those issues (here, here, here, here, and here), and if you’ve been following along the past couple of months, you’ll know the whole performance thing doesn’t really hold any water after a strong 2014 {past performance is not necessarily indicative of future results}.

But there were some pretty charts and some stuff we agreed with:

Portfolio Allocation

We couldn’t agree more with this point from a McKinsey report.

“That recent McKinsey report asserts that investors are increasingly disillusioned by traditional asset classes and concludes that the demand for alternatives is driven by powerful structural forces leading investors to seek consistent and uncorrelated risk-adjusted returns.”

And we’ll add our own take – that advisors and investors don’t have plausible deniability anymore. 2008 snuck up on most of us, and caught a lot of people off guard. But it’s there for all to see now, and prudent investors are taking steps to protect against another such crisis. They know it can happen, and they want some better protection this time around.  Seawright provides the numbers to prove it. Barron’s asked the Top 40 Asset managers what allocations make up their portfolio, and last year, the average of them all had a 19% allocation to “Alternatives.” Here’re the breakdown:

The concensus portfolio

More specifically, the actual allocations to particular asset classes.

The concensus portfolio 2Charts Courtesy: Above the Market

Now, what we would have said at this point in the article is… beware the high correlation to stocks and the economy at large in the ‘Alternatives’ allocations to Real Estate, Hedge Funds, and especially Private Equity (it has equity right there in the name). For more on how these ‘Alternatives’ aren’t all that alternative, check out our recent Whitepaper: Truth And Lies in Alternative Investments.  And maybe that’s what he’s trying to say – is that all this money flowing into these Alts is bound to feel a little disappointed when the next crisis does come.

Consistent Returns = Pipedream

Seawright takes the McKinsey report’s line that investors are investing in Alts to achieve consistent returns to say their looking in the wrong place with Alternatives, and instead should just be looking at Bonds and holding them to maturity. He goes on to quote Yale legend David Swensen in a sort of, even the guy who promoted Alts concedes that they won’t be steady and predictable, way.

“As Swensen himself concedes, “The most attractive investment opportunities fail to provide returns in a steady, predictable fashion.” Volatility is a necessary consequence of the risk premium afforded by equities.”

Swensen is basically saying you can’t get more return without more risk,  and we couldn’t agree more. And that’s where the second part of the line about investor appetite for Alts comes in. Remember, they said they were looking for ‘risk adjusted returns’. That’s the part most everyone misses when panning Alts.

Investors are trying to get a fair increase in return for an increase in risk (over just holding bonds). Yes, they are being sold this promise; but we’re also talking about the Top 40 Asset Managers in the US, surely there’s some smart people among those 40 allocating to Alts because they see a benefit to it beyond what the sales person is telling them. Surely they have their own portfolio modeling tools and own thoughts on the future volatility of stock and bond prices (assuming bonds will be steady moving forward is a topic for another day).

Gathering Assets vs Managing Assets

Seawright finishes off by talking about the declining performance of large managers;

“… in the aggregate, by this point it should be clear that most alternative investment vehicles are less a vehicle for managing assets and more a vehicle for acquiring assets and fees.”

Here’s the thing – investors don’t invest in the aggregate. They invest in specific managers with specific stories. They can choose to invest in smaller, more nimble managers who don’t have the size issue and are still focusing on performing versus growing assets. They can choose to go with lower fee products or fund classes or providers who truly are looking out for the investor’s best interest.

And they can choose which hedge fund style they invest in… deciding, perhaps to replace their equity exposure with private equity and a long short strategy. To replace a part of their bond allocation to alternatives not tied to the economic cycle such as managed futures programs which can go both long and short global markets.

PS – if you really want to follow the money, check out non-traded REITS.


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