The results of Russell Investments’ 2012 Global Survey on Alternative Investing demonstrate a growing demand for alternative assets among institutional investors. Ninety percent of respondents are allocating to alternatives for their diversification benefits. Closely aligned with this theme is alternatives’ lack of correlation to traditional asset classes and the resultant reduction in total portfolio volatility that may be achieved.
The results also point to the potential for increased allocations to alternatives over the next one to three years. Of the 146 institutional investors surveyed in North America, Europe, Australia and Japan, 32% expect to increase investment in hedge funds and private real estate over the short term; 28% will look to private infrastructure, 25% to private equity, 20% to commodities and 12% to public real estate and infrastructure.
But as Canadian institutions seek to better diversify their portfolios and better manage their risk exposure through alternatives, a challenge lies in the area of implementation. Successful implementa-tion of alternative investing requires a focus on specialized research around management of alternative investments and risk management. The key question becomes, How do I increase exposure to alternative investments without materially increasing complexity and cost to my organization?
The experience with Canadian investors has been to assess opportunities and risks across the universe of alternative investment strategies and implementation approaches to help ensure that portfolios are aligned with objectives. This also incorporates practical issues such as governance structure and the level of internal investment resources.
For instance, an opportunistic credit portfolio solution specifically targets credit strategies and managers that exploit supply/demand dislocations across the credit markets and offers highly attractive risk-adjusted return potential. The investment is structured with a drawdown feature in which spacing out capital deployments over time helps balance the dual risk of current opportunity cost and the risk of not being able to take advantage of future market dislocations due to a lack of available capital. The investor is able to benefit from preferential terms, including reduced fees, improved governance and greater transparency.
Another case could be tactical trading. If investors want to expand their program in a manner that complements an existing manager, this strategy can help them gain exposure to a broader range of tactical trading strategies (i.e., discretionary macro, managed futures, relative value commodities) to fully capture the potential risk reduction benefits that tactical trading provides.
These examples show how Canadian institutions could adopt a holistic approach to their alternative investment portfolios and create solutions designed to address desired portfolio outcomes. This is a very different approach from the early- to mid-2000s, when investors entered the market and largely allocated to off-the-shelf products such as commingled or pooled funds.
Due to the dynamic nature of products and investing strategies in the still-evolving alternative investment space, there is a growing need for comprehensive education, strategy development and manager due diligence (incorporating both investment and operational factors). There is, therefore, an increasing trend among institutional investors to work with external resources. Even some sophisticated investors have decided that they could better achieve their objectives by combining internal and external resources to manage alternative investment portfolios. Successful implemen-tation is just as important as choosing the right mix of assets. By using external resources, investors can be confident that their portfolios are practical in dealing with the realities of today’s investment landscape and well positioned to meet their objectives into the future.
Darren Spencer is director, alternative investment consulting, Americas Institutional, with Russell Investments. dspencer@russell.com