In this rapidly evolving market environment, it is not surprising that asset allocations for institutions are expected to follow suit and undergo many changes in the near term. Institutional investors worldwide are anticipating more asset allocation changes in the next one to two years than in 2012 and 2014, according to the Fidelity Global Institutional Investor Survey. Now in its fourteenth year, the survey indicates that 72% of institutional investors plan to increase their allocation of illiquid alternatives in 2017 and 2018.
Alternative investments can be used alone to address unique investment objectives, or together within a portfolio to complement other strategies that have different risk and return profiles. We believe that investing in alternatives can offer a range of benefits to investors, including the potential for uncorrelated returns, reduced volatility and, in some cases, additional tail risk protection. Investments in real estate and infrastructure also have the potential to generate sizable yield. In this paper, we will look at a variety of alternative investment strategies and the potential strengths they have when added to a diversified portfolio.
Private Equity & Venture Capital
Private equity and venture capital have always offered the potential for outsized returns compared to public markets, but investors should consider focusing on certain areas of the market to maximize the utility of these asset classes. Smaller deal sizes in private equity and earlier stage investments in venture capital offer a significant opportunity to generate outsized returns, provided that investors conduct thorough research and due diligence.
Real assets: Mid-stream energy and timberland
Within real assets there are several sub-asset classes including: energy (including upstream and midstream oil and gas, power, and infrastructure assets), mining and minerals, timber, and agriculture. This diversity adds complexity, and investors should consider partnering with an experienced and skilled team to be able to identify particular investment themes and opportunities and match them with the right general partner (GP) or operator to fully exploit the opportunity.
Private infrastructure capital needs have increased as global governments work to rebuild or advance their countries. Mature infrastructure assets can provide stable income over the long-term, while growth and development infrastructure assets can generate strong capital appreciation. Across these lifecycles, infrastructure is a fast-growing asset class that may be enhanced with proper active management.
Global economic uncertainty has renewed investor interest in hedge funds. Hedge fund assets include an array of strategies that can help diversify risk while generating returns. But not all hedge funds are the same, which means thorough due diligence and a deep understanding of individual strategies may be critical in making advantageous investments.
Property can be an important source of diversification within a multi-asset portfolio. In today's “lower for longer” interest-rate environment, it is one of the few asset classes that can still offer opportunities for significant yield, as well as the potential for growth.
Conclusion: intelligent diversification
Alternatives offer a vast array of different strategies and styles to fit a variety of investor risk and return objectives. Each alternative investment strategy has unique characteristics that make it well-suited for its purpose. That purpose may be to generate new sources of alpha within a portfolio, mitigate risk in distressed markets or unlock new opportunities within a largely unconstrained investable universe.
While the use of alternatives has become much more widespread in recent years, investors should keep in mind that these are complex strategies, and as such they require an in-depth understanding gained through extensive and often time-consuming research. Partnering with an institutional alternatives platform can offer the resources needed to identify complementary strategies for a diversified portfolio.
Having an allocation to one or more alternative strategies is like having a specialized toolkit to help you with your goals. Finding the right strategies for your objectives and deciding upon an appropriate allocation within your portfolio can help you enhance a diversified allocation and gain new sources of investment returns. With alternatives, there are a variety of solutions that investors can employ to diversify their portfolios.