Institutional investors can't get enough of alternative investments.
In wide-ranging interviews with chief investment officers at pension funds and endowments, Pensions & Investments found broad satisfaction with the performance of real estate, private equity and hedge funds, as well as with the diversification they add to investment portfolios.
Many of the CIOs attributed their funds' strong performances last year specifically to alternative investment returns.
At the same time, capacity constraints remain the CIOs' top frustration.
Long waiting lists or limited mandate sizes are the norm these days, particularly for core real estate, hedge funds, venture capital and certain private equity strategies. CIOs at public pension funds said finding capacity is even harder for them because public disclosure rules often lead many private equity funds to bar them as investors.
Still, returns for most types of alternative investments are expected to best public stocks and bonds. With projected annualized returns of between 7% and 7.5% for core equity and 5% for core fixed income over the next five years, institutional investors will have to look elsewhere — such as real estate, private equity and hedge funds — to achieve an overall portfolio return of 8%, said Joe Nankof, partner at consultant Rocaton Investment Advisors LLC., Norwalk, Conn.
"Pension funds have to find a way to get returns. They have to grow back their underfunded liability and prevent it from getting worse. They are running scared," said Michael C. Schlachter, managing director of Wilshire Associates Inc., Santa Monica, Calif.
"A 5% to 10% allocation (to alternatives) can bring meaningful returns but increases the risk. They bring up returns in a world where you are no longer going to get 12% from stocks and 8% from bonds."