So, have allocations to alternative asset classes provided the desired diversification and return potential? The answer to that question is both yes and no. Certainly, the lure of easy money impacted some private equity, infrastructure and real estate investments which were highly levered. As a result of the credit crisis in 2008, much of that debt has been marked down, and the prospects for the investments themselves have been impaired by the economic slowdown that ensued in much of the developed world. Many hedge fund strategies did not provide the low beta correlation they promised as the drive for returns in the prior period forced them to over lever and accept too much directional exposure. High fees have also impaired the return potential for private equity and hedge fund of funds, and to a lesser extent infrastructure. While we are starting to see some movement in fees in these asset categories, we believe fees remain too high.
Despite all of the above, there were many alternatives products that did fare well and continue to do so. Canadian real estate has been one of the best performing asset classes in Canada over the past 10 years. Canadian social infrastructure has also been a strong performer. Secondary and distressed private equity investments have been very attractive over the past couple years.
One of the key lessons pension plan sponsors learned was that alternatives are not a panacea—they remain governance intensive asset classes where manager selection is paramount along with strong sponsor oversight. Many plan sponsors do not have the resources to fulfill either of these preconditions for success. On this basis, we expect to see the allocation to alternatives increase, though not at the same pace as in prior years.
Janet Rabovsky is a senior investment consultant with Towers Watson.
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