Sponsors are committing increasing amounts of assets to alternative investments and are especially interested in making those investments overseas, according to a new joint survey by Goldman, Sachs & Co., New York, and Frank Russell Co., Tacoma, Wash.
The latest Goldman/Russell study, a follow-up to a joint 1992 report, found total dollar commitments to alternative investments has grown to $69 billion from $36 billion in 1992.
Alternative investments totaled 5.5% of the assets of the funds polled for the study - the 1995 Survey of Alternative Investments by Pension Funds, Endowments and Foundations - up from 3.6% of dollar assets in 1992. By comparison, real estate, a more traditional non-security asset class, decreased to 3% from 4%.
The average target allocation among funds that said they invest in alternative investments is 6.2% of assets. Of the funds surveyed, 25% had increased their alternative investment allocation in the past three years, to an average of 7.3% from 4.8%. In the future, 18% of funds plan to increase their allocation in the next three years, to an average of 7.5% from 4.7%.
When asked for their main reason to participate in alternative investments, approximately 75% of the respondents cited the expectation that it would outperform traditional asset classes, said Thomas J. Healey, a partner at Goldman Sachs and head of the firm's pension services group. Outperforming traditional investments was named as critical by 74% of respondents and important by another 23%. Diversifying the portfolio was named as critical by 40% and important by 48%, while hedging inflation was critical to 4% and important to 21%.
Sponsors placed their average expected return in the alternatives class at "north of 15%," said Mr. Healey. Seeing those results, one can guess sponsors are eying alternative investments while expecting a reversion to the mean among the public markets, said Donald J. Hardy, a managing director of Frank Russell Capital Inc., a subsidiary of Frank Russell Co.
While the percentage of assets allocated to alternative investments and the dollars committed to it are both growing, the percentage of funds investing in the class is static, Mr. Healey said.
The percentage held steady at 63% from 1992 to 1995 among endowments and foundations, rose to 61% from 56% among corporate pension funds and dropped to 49% from 53% among public funds.
"It's the same people doing more," said Mr. Healey.
The changes have come in the size of the funds investing in alternatives, said Mr. Hardy. According to the study, the percentage of dollar commitments among funds with less than $3 billion in assets dropped to 3.9% from 13% in 1992, while the percentage from funds $3 billion to $10 billion grew to 28.9% from 17.9%.
One possible explanation is that small funds want to invest but lack the infrastructure to access such a specialized asset class, said Mr. Hardy.
Additionally, large endowments and foundations, the traditional leaders in alternative investments, all fit in the $3 billion to $10 billion category, said Mr. Healey. Endowments and foundations are the most aggressive investors, allocating an average 10.9% of assets. Corporate funds allocate an average 6.7% of their assets, while public funds hold 4.3%.
The most popular types of alternative investments are leveraged buy-out funds, which attracted 43.9% of dollar commitments, followed by venture capital, 22.3%, and mezzanine financing, 6.5%.
Nearly all types of alternative investments saw a drop in dollar volume in favor of LBO funds, which had drawn 41% of dollar commitments in 1992; the only other category to gain in commitments was international private equity, which had registered a negligible allocation in the 1992 survey, but attracted 5.8% of dollars in 1995.
Of the sponsors committing assets to international private equity, 55% are investing in emerging markets and 45% in developed countries, but nearly two-thirds of the dollar commitments are in developed markets, while 36% of the dollars are in emerging markets.
Among the developed markets, Europe accounts for 91.6% of the dollars committed and Asia the remaining 8.4%. Among dollar commitments to emerging markets, Asia (excluding China) makes up 61.7%, China is 20.2% and Latin America is 11.9%; the former Soviet Union, South Africa and Eastern Europe make up the rest.
Despite the increase in commitments, venture capital was more popular than LBO funds in terms of the percentage of funds participating in those investments; while LBO funds attracted 17.4% of funds allocating assets to alternative investments, 25.8% of them invested in venture capital.
There are fewer LBO funds but they are larger, while there are many more - but smaller - venture capital funds, said Mr. Healey. LBO funds are characterized by large investors committing large amounts of money, said Mr. Hardy.
Return expectations also seemed to govern the choice of alternative investments. The average return expectation for international private equity is 18% over the next three years. LBO funds are expected to return 17%; venture capital, 16%; and mezzanine funds, 11%.
Mezzanine funds are down because of the expected lower return, said Mr. Hardy. People who are going to sacrifice liquidity to invest in alternatives won't do it for an 11% return, he said.
Limited partnerships are the most popular vehicle for alternative investments, attracting 84.4% of sponsor dollar commitments, compared with 80% in 1992. Direct investments dropped to 10.4% of commitments from 13%, co-investments dropped to 3% from 4.5% and funds of funds were down to 2.2% from 2.5%.
The Goldman/Russell survey polled 254 plan sponsors in the United States and Canada using questionnaires and telephone interviews to compile the report. The respondents include public, corporate and union pension funds; foundations and endowments. The respondents cover $1.9 trillion in assets, including all pension funds with more than $3 billion in assets and several funds with $500 million to $3 billion.