Feb 2017 by Caroline Rasmussen
Our high-net-worth investor network is placing a premium on the benefits associated with alternatives going into 2017, with 31% of respondents in our post-election survey indicating that diversification and the potential for risk mitigation and outperformance will be of increased importance under a Trump administration.
While the advantages of adding alternatives can be significant at any point in the market cycle, this is particularly true in volatile markets. With 69% of our network expecting increased market volatility under Trump, it is no surprise that almost a quarter of respondents plan to invest more in alternatives this year, including private equity and hedge funds. (See full post-election survey results here.)
The benefits of incorporating alternative investments into a traditional portfolio include:
The illiquidity premium. Although different types of alternatives have varying degrees of illiquidity, investments such as private equity and venture capital funds are typically offered via limited partnerships that can have terms of up to 10 years. Investors in these illiquid funds expect to be compensated with improved returns in exchange for locking up their money. In general, the more illiquid the investment, the higher the potential return, a relationship described as the “illiquidity premium”. Historically, private equity has outperformed public market indices by 3-4% on a net basis over long time periods1, with top quartile managers generating significantly more alpha.
Risk mitigation. An allocation to alternatives may help hedge against market volatility and improve the risk/return profile of a portfolio. While correlations across virtually all asset classes spiked during the most recent financial crisis, alternatives have typically not fallen as far as stocks during market sell-offs. For example, global macro funds experienced maximum drawdowns of less than 5% during 2008, and managed futures were down less than 4% at the peak, compared to 38% for stocks2. Non-traded alternative investments such as private equity not only avoided abrupt drops in value as a result of their private nature, but also took the opportunity to buy assets on the cheap during market turmoil, with funds invested in the three years following the crisis seeing a meaningful jump in returns3 compared to funds from the years leading up to the crisis.
Diversification. Because they can invest in different types of assets and employ a broader toolkit than traditional long-only public strategies, alternatives can add critical diversification to a portfolio. According to the US Census, there are approximately 6 million companies in the U.S.4, only about 6,000 of which are listed on the New York Stock Exchange5 and the NASDAQ6 combined. Therefore, investors that invest their entire portfolio in the public markets lack direct exposure to the vast majority of economic activity in the United States. The diversification potential of alternatives also extends to the hedging strategies and esoteric investments such as derivatives that many hedge funds deal in, all of which can add important new exposures to a portfolio.
While alternative investments provide the potential for attractive returns, they also have features and risks not typically present in public markets, including but not limited to:
• Investments will be illiquid for a period of time, which means it cannot be sold, transferred or redeemed at will or for reasons of hardship
• The manager’s investment strategy may not be fully or successfully implemented as intended
• There may be significant execution and operating risks that could negatively impact investors
• Part of all of the principal investment may be at risk or lost
• Past performance is not an indication of future results
Past performance is not indicative of future results. Historical returns are included solely for the purpose of providing information regarding private equity industry returns and returns of other asset classes over certain time periods. While investments in private equity funds provide potential for attractive returns, they also present significant risks not typically present in public equity markets, including, but not limited to, illiquidity, long term horizons, loss of capital and significant execution and operating risks.
These materials are for informational purposes only and are not intended as, and may not be relied on in any manner as legal, tax or investment advice, a recommendation, or as an offer to sell, a solicitation of an offer to purchase or a recommendation of any interest in any fund or security described herein. Any such offer or solicitation shall be made only pursuant to a fund’s final confidential offering documents which will contain information about each fund’s investment objectives and terms and conditions of an investment and may also describe certain risks and tax information related to an investment therein. This material does not take into account the particular investment objectives, restrictions, or financial, legal or tax situation of any specific investor. An investment in the fund is not suitable for all investors.
Past performance is not indicative of future results. Any products made available to clients of iCapital, are private placements that are sold only to qualified clients of iCapital through transactions that are exempt from registration under the Securities Act of 1933 pursuant to Rule 506(b) of Regulation D promulgated thereunder (“Private Placements”). An investment in any product issued pursuant to a Private Placement, such as the funds described, entails a high degree of risk and no assurance can be given that any alternative investment fund’s investment objectives will be achieved or that investors will receive a return of their capital. Further, such investments are not subject to the same levels of regulatory scrutiny as publicly listed investments, and as a result, investors may have access to significantly less information than they can access with respect to publicly listed investments. Prospective investors should also note that investments in the products described involve long lock-ups and do not provide investors with liquidity.
The information contained herein is subject to change and is also incomplete. This industry information and its importance is an opinion only and should not be relied upon as the only important information available. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.
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