Commentary: Weatherproofing multiasset portfolios with illiquid alternatives
Skip to main content
pilogo-NEW
Subscribe
  • Subscribe
  • My Account
  • login
  • NEWS
    • Asset owners and the coronavirus
    • Alternatives
    • Consultants
    • Coronavirus
    • Defined Contribution
    • ESG
    • Frontlines
    • Hedge Funds
    • Investing / Portfolio Strategies
    • Money Management
    • Pension Funds
    • People Moves
    • Private Equity
    • Real Estate
    • Searches & Hires News
    • SECURE Act
    • Special Reports
    • WorldPensionSummit
    • Ron Schmitz
      Pandemic drives faster transition for Virginia to private markets
      Mubadala Investment Co. logo
      Mubadala draws on portfolio in coronavirus fight
      T.J. Carlson
      Texas Muni reduces downside risk during pandemic, finding opportunities now
      Scott Davis
      ‘Triage plan’ at Indiana system helped stem losses
    • BentallGreenOak agrees to acquire Metropolitan Real Estate Equity
      watch video
      0:45
      Private funds weathered 2020 turmoil
      Daniel McHugh
      Aviva Investors promotes from within for real assets CIO
      Marc Rowan
      More alts managers seek expansion to retail market
    • Kieran Mistry
      Hymans Robertson picks head for new non-traditional risk transfer unit
      Troy Saharic
      NEPC brings on director of new business development
      Bill Foley
      Foley-backed SPAC agrees to $7.3 billion deal with Alight
      Jason Schwarz, chief operating officer of Wilshire,
      New owners have big plans for future of Wilshire
    • Bain: Private equity managers finish 2020 strong
      Eastern Colorado VA Receives Shipments Of Covid-19 Vaccines
      Fidelity looks to speed vaccinations to get workers back to offices
      OMERS CEO Blake Hutcheson
      OMERS records worst loss since 2008 on bad COVID-19 bets
      Mitchells & Butlers turns off tap on pension contributions until April
    • A  Malaysia flag flies in Putrajaya on Sept. 23, 2020
      Malaysia’s EPF ends 2020 up 7.9% at almost $250 billion
      Database’s debut focuses on public-sector DC plans
      DC plan sponsors differ on need for annuities – survey
      Biden’s retirement idea getting the cold shoulder
    • Emissions from a smokestack in Poland
      Asset managers facing more scrutiny on ESG issues – report
      Boris Johnson, U.K. prime minister, hosts the U.N. Security Council's virtual meeting on climate change risks in London on Feb. 23, 2021
      Progress in fighting climate change falls short – U.N.
      Justin Trudeau, Canada's prime minister, smiles during a virtual joint news conference with U.S. President Joe Biden in Ottawa on Feb. 23, 2021
      U.S. joins forces with Canada on climate change
      Signage is displayed at Harvard University Health Services in Cambridge, Mass., on April 20, 2020
      Harvard endowment’s fossil-fuel investments drop to 2% of assets
    • 2 U.K. pension execs take on ESG investing in new podcast
      Donation illustration
      Jefferies will use trading commissions to do good
      Michael Arougheti
      SPACs ride wave as latest investment darling
      Spirit winners
      Prudential honors young people who are helping out
    • Robert 'Rob' Shafir listens during a Senate Permanent Subcommittee on Investigations hearing in Washington on Feb. 26, 2014
      Sculptor hedge fund hits sixth straight year of outflows
      The WallStreetBets forum on the Reddit Inc. website on a laptop computer and the GameStop logo on a smartphone in an arranged photo.
      GameStop frenzy has hedge fund managers rethinking next moves
      Gabe Plotkin, chief investment officer and portfolio manager of Melvin Capital Management, speaks during the Sohn Investment Conference in New York on May 6, 2019
      Citadel, Point72 back Melvin with $2.75 billion after losses
      Shanghai skyline
      Global hedge funds struggle even in a more open China market
    • Bain: Private equity managers finish 2020 strong
      Metlife Investment Management selects new head of real estate equity
      Servant-Rainsford combo
      Generali Group picks CEOs for money management businesses
      Abu Dhabi is biggest employer of wealth fund executives
    • Metlife Investment Management selects new head of real estate equity
      Eric Lane departs Goldman for Tiger Global
      Eastern Colorado VA Receives Shipments Of Covid-19 Vaccines
      Fidelity looks to speed vaccinations to get workers back to offices
      Servant-Rainsford combo
      Generali Group picks CEOs for money management businesses
    • A  copy of the Daily Mirror newspaper is removed from the production line at Trinity Mirror's factory in Watford, U.K., on April 13, 2010
      Media group Reach inks buy-in deal for pension fund
      Illinois Teachers preliminary returns falls short of benchmark
      Thomas Spencer
      Oklahoma Teachers chief Tom Spencer to retire
      Swedish flags fly from a tourist souvenir shop in Gamla Stan in Stockholm on March 26, 2020
      Sweden’s AP1 gains 9.7% in 2020
    • Metlife Investment Management selects new head of real estate equity
      Eric Lane departs Goldman for Tiger Global
      Servant-Rainsford combo
      Generali Group picks CEOs for money management businesses
      K. Niles Bryant
      Bowdoin College names new CIO
    • Bain: Private equity managers finish 2020 strong
      Carlyle secures $4.1 billion ESG-related credit facility
      Hamilton Lane raises $3.9 billion for fifth secondary fund
      PSG closes first Europe-focused fund at $1.5 billion
    • AEW chooses head of fund operations and debt finance
      Sebastiano Ferrante and Jocelyn de Verdelon
      PGIM Real Estate turns to staff to fill new roles
      European managers key in on specialist strategies
      Ingrid Jacobs
      Jones Lang LaSalle brings on head of diversity and inclusion
    • Retirement cartoon
      Hopes rising for retirement readiness in 2021
      Neal and Brady
      Retirement security could be only issue both sides accept
      David Ireland
      Sponsors returning to questions about in-plan annuities
      Shawn O'Brien
      Annuities coming to target-date funds, but not right away
    • Charging Bull, sometimes referred to as the Wall Street Bull or the Bowling Green Bull, a bronze sculpture that stands on Broadway just north of Bowling Green in the Financial District of New York City
      Top-performing managers Q4 2020
      P&I 1,000 largest retirement plans: 2021
      Retirement in emerging markets
      Outlook 2021
    • U.S. still a key market for investors
      Collected coverage of P&I's 2020 WorldPensionSummit
      Pedestrians pass a large advertisement on the Arndale Center shopping mall reading 'Act now to avoid a local lockdown' in Manchester, England
      COVID-19 puts new opportunities and risks on the agenda - WPS panelists
      Screens display stock price information over the trading floor of the NYSE Euronext exchange in Paris
      Private assets will continue to grow in portfolios – WPS panelists
  • Data
    • Research Center
    • Searches & Hires Database
    • Searches & Hires News
    • RFPs
    • Charts / Infographics
    • Sponsored Research
    • Trackers
    • Q2 2020 searches and hires overview report
      Q2 2020 money manager M&A activity summary
      Q2 2020 legal overview report
      Q1 2020 searches and hires overview report
    • Los Angeles Fire & Police slates $80 million for real estate, private equity
      Chicago Water scouring for global equity manager
      New York Deferred Comp plan preps international equity search
      Baltimore City Fire & Police commits $15 million to infrastructure fund
    • Los Angeles Fire & Police slates $80 million for real estate, private equity
      Chicago Water scouring for global equity manager
      New York Deferred Comp plan preps international equity search
      Baltimore City Fire & Police commits $15 million to infrastructure fund
    • Actuarial Services
      Emerging Market Equity Manager Services
      Securitized Credit Manager Search
      Private Placements Asset Manager Search
    • Taiwan Semiconductor’s No. 1 in the emerging markets book
      U.S. fixed-income returns post another positive year
      Nasdaq delivers an impressive year
      U.S. dollar's recent decline continues
    • Institutional Investors: Shared Expectations, Divergent Paths
      Global Investor Study 2016
      Workplace Financial Wellness
    • U.S. Endowment Returns Tracker
      Pension Fund Returns Tracker
      Earnings Tracker
      Corporate Pension Contribution Tracker
  • Insights
    • Opinion
    • White Papers
    • Industry Voices
    • Letters to the Editor
    • Partner Content
    • Publisher's Update
    • Tesla cartoon
      Don’t confuse wealth creation with retirement saving
      Top 1000 cartoon
      Top 1,000 retirement plans weather storm just fine
      Infrastructure cartoon
      You must go big on infrastructure, Mr. President
      Retirement cartoon
      Hopes rising for retirement readiness in 2021
    • Investment Trends: Looking Ahead Across Equity Sectors
      Rethinking Market and Reference Data Management
      China is embarking on a new stage of growth
      Gold Outlook 2021
    • Sameer Shalaby
      Commentary: Why should investors care about treasury management?
      David Blitzstein
      Commentary: Without a national retirement policy, Americans face a future of pension crises
      Lawrence Cunningham
      Commentary: Gensler should keep Clayton’s pragmatic proxy adviser rules
      My-Linh Ngo
      Commentary: Pension funds and the role of the debt market in the fight against climate change
    • Writer using a typewriter
      OCIO industry needs to adopt GIPS
      Writer or journalist workplace. stock illustration
      Even as it assails China, Trump administration emulates it
      Skeptical of Main Street support for proxy adviser proposal
      Focus on manager diversity pushes asset owners’ to walk the talk
    • P&I Content Solutions
      How will gold react?
      To people shaking hands
      P&I Content Solutions
      Lessons From 2020: Today’s OCIO Model Passes a Major Test of Governance
      Sponsored Content By MassMutual
      Leveraging Data to Manage Risk
      Sponsored Content By iShares
      ETFs are becoming a cornerstone of insurance equity portfolios
    • Help us help you by supporting quality journalism
      You Must Believe in Spring
      Everything Must Change
      Tomatoes & Investments
  • Multimedia
    • Videos
    • Webinars
    • Polls
    • Slideshows
    • Charts / Infographics
    • watch video
      0:45
      Private funds weathered 2020 turmoil
      watch video
      0:59
      Secure choice and other retirement plans at a state level
      watch video
      3:33
      P&I 1,000 by the numbers 2021
      watch video
      1:33
      A look at hiring activity in 2020
    • Emerging Markets: Expanding Investors’ View
      2021: A Fixed Income Odyssey
      Technology is the New Oil: The Changing Nature of Emerging Markets
      Powering the Change: The power of diversity and inclusion
    • POLL: Working after the pandemic
      POLL: The year ahead for the 1,000 largest U.S. retirement funds
      POLL: The Biden administration’s economic plans
      POLL: Retirement issues in 2021
    • view gallery
      9 photos
      Coronavirus and the markets
      view gallery
      22 photos
      The 1,000 largest retirement funds: 2020
      view gallery
      10 photos
      Outlook 2020
      view gallery
      10 photos
      2019 as seen through the eyes of Roger
    • By the Numbers for February 2021
      Top Performing Managers of Leveraged Net Long (SA Only), 4th Quarter 2020
      Top Performing Managers of Market Neutral (SA Only), 4th Quarter 2020
      Top Performing Managers of U.S. Stock, 4th Quarter 2020
  • Events
    • Conferences
    • Webinars
    • Defined Contribution Spring Virtual Series
      DC Investment Lineup Virtual Series
      ESG Investing Virtual Series
      Private Markets Virtual Series
    • Emerging Markets: Expanding Investors’ View
      2021: A Fixed Income Odyssey
      Technology is the New Oil: The Changing Nature of Emerging Markets
      Powering the Change: The power of diversity and inclusion
  • Careers
  • Research Center
MENU
Breadcrumb
  1. Home
  2. INDUSTRY VOICES
December 17, 2020 07:00 AM

Commentary: Weatherproofing multiasset portfolios with illiquid alternatives

Real-time cash-flow forecasting may hold the key to true diversification

Thomas Meyer
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print
    Thomas Meyer
    Photo: Oliver Doll
    Thomas Meyer

    Sophisticated institutions have long been investing in illiquid alternatives, such as private equity and real assets, to improve the diversification and performance of their portfolios. But during the COVID-19 crisis, many institutional investors across the globe found their portfolio risks were far more concentrated than expected. It appears, at least in practice, implementing a well-diversified portfolio to weatherproof against market shocks is more difficult than widely assumed.

    In a recent public meeting for the California Public Employees' Retirement System board of administration, Greg Ruiz, head of CalPERS' private equity program, reflected on why its renowned program has recently underperformed relative to peer benchmarks. In his review, he identified a "lack of disciplined capital deployment and lack of strategic consistency," as the two key factors that affected performance.

    Mr. Ruiz's reflections could well be the key to riding out the current global pandemic, if we can ascertain just how limited partners can sustain their approaches to alternative allocations, to weatherproof portfolios against the storms in the market. To understand this, we must take a look at the role of market practices and short-termism and whether frequent cash-flow forecasting may hold the key to true diversification.

    The ‘denominator effect’

    Many institutions invest in a collection of assets, following a decades-old best practice strategy, approximately defined as 40% equities, 30% bonds, 10% hedge funds, 10% private equity, and 10% real estate and infrastructure. Following these rules implicitly allows market quoted assets to drive portfolio dynamics. If we consider an allocation as the capital within an asset class, divided by the total capital of the portfolio, when one asset class, such as equities, takes a hit, it skews the relative value of other less liquid asset classes, such as private equity. In this sense, the value of private equity blooms, while the overall portfolio (the denominator) reduces significantly. This is known as the denominator effect; a typical phenomena arising during crises.

    This temporary overallocation of illiquids within the total portfolio causes many limited partners to take a typical short-term market risk perspective and put a stop on any new fund allocations, or even sell off current commitments in the secondary markets, in favor of rebalancing allocations and increasing liquidity during volatile conditions.

    This self-harming act, a result of overly rigorous market rules designed for liquid asset classes and not for illiquid alternatives, sees LPs create a self-fulfilling prophecy. Firstly, injecting artificial volatility from the public markets into the private markets. Secondly, selling off private assets in usually highly unfavorable conditions due to declining asset values. Instead of using these conditions to buy illiquid assets at a discounted value, many LPs flee the market in their hordes, precisely at a time when it is mostly likely to dry up.

    Keep calm and carry on

    Private equity and real assets resist the volatility caused by increased market transactions as a means to rebalance and provide stability to multiasset portfolios. It is one of the rudimental characteristics that define it from traditional assets, such as equities. Take the global financial crisis in 2008 and 2009 as an example, where an illustrative portfolio of private equity funds showed a contraction of distributions by 65%, while contributions decreased by 20% relative to predictions. This is a development to be expected during a market crisis, where valuations for all assets are collapsing.

    However, this impact occurred over a relatively short term. In 2012, the same sample of private equity funds had caught up and its cash returns, as well as its overall performance, were well beyond what was predicted/expected in 2009. To draw a key lesson from the global financial crisis and other crises: A consistent approach to fund commitments is critical. Institutional investors that stay the course and hold tight with private equity and other alternatives allocations will ultimately benefit from risk-adjusted returns generated by funds once markets recover. As CalPERS' Mr. Ruiz confirms, while consistently committing to private equity does not always guarantee success, inconsistently deploying capital will most certainly result in underperformance.

    In most of these situations, the old dictum to "keep calm and carry on" is the advisable course of action. However, this is easier said than done. One of the contributing factors that perpetuates the artificial risk mindset of most LPs in a crisis is the lack of counterargument from their illiquid asset teams. Here, risk management is predominantly approached through business acumen and due diligence, rather than through the quantitative models and tools needed to communicate risks in the "value-at-risk" language their organizations urgently demand.

    It’s all about cash flow

    Weatherproofing has to start long before a crisis. If, for instance, an integrated cash flow forecasting solution had existed back during the GFC, its timely insight, backed by robust data, would perhaps have enabled a strong counterargument from the illiquid asset teams, eliminating the hasty decisions that a public market risk perspective often triggers.

    The dynamics of fund cash flows play a critical and challenging role in meeting diversification targets. Sophisticated asset managers confirm that careful liquidity planning is essential to achieve this, but often this insight is either stuck in the back office, never to make its way to the trading desk. Or based on yearly forecasts that become quickly outdated and offer little accuracy to guide portfolio allocation decisions in the here and now.

    Much of the challenge around cash-flow forecasting models is that they need to be able to work with infrequent, unstructured and poor-quality data that is the signature pattern of illiquid alternative assets. The algorithms need to use both proprietary private market data, supplemented by data obtained from market vendors, and triangulate to fill the remaining gaps. In situations where investors try to build an in-house system for cash-flow forecasting, the development quickly turns into a quagmire, overcomplicated by attempts to capture all details, where accessing and maintaining such data becomes a nightmare, and no model is considered good enough.

    Instead of striving for illusive precision, when it comes to long-term forecasts, the key to gaining control is making cash-flow forecasting a continuous, e.g., monthly, discipline within the investment process. This can be achieved by an integrated front-to-back, cash-flow forecasting solution that can readily make real time data available across the organization.

    By integrating with a firms' investment book of record, such a solution could deliver critical visibility on liquidity and exposure across all asset classes. This vital tool can enable LPs fast access to consolidated data, to accurately and credibly assess liquidity exposure and reliably inform allocation decisions.

    Innovation like this would not only enable LPs to compare apples (public markets) and oranges (private markets) more accurately, but empower illiquid asset teams with statistical data, to quickly demonstrate what they already know to be true but lose sight of in the haze of a global market event: that private assets do not correlate, in the long term, with their public market counterparts. This is the fundamental premise upon which multiasset portfolios are formed, to weatherproof, come rain or shine.

    Thomas Meyer is Luxembourg-based product manager, director of alternative investments at SimCorp. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.

    Related Articles
    U.K. fund liquidity rule breaches soared in COVID-19 early days
    Investors discover some weaknesses with private credit
    Commentary: Investment management survival tips in the COVID-19 environment
    Recommended for You
    Commentary: Why should investors care about treasury management?
    Commentary: Why should investors care about treasury management?
    Commentary: Without a national retirement policy, Americans face a future of pension crises
    Commentary: Without a national retirement policy, Americans face a future of pension crises
    Commentary: Gensler should keep Clayton’s pragmatic proxy adviser rules
    Commentary: Gensler should keep Clayton’s pragmatic proxy adviser rules
    How will gold react?
    Sponsored Content: How will gold react?
    sponsored
    Events
     
     
    Sponsored
    White Papers
    Rethinking Market and Reference Data Management
    Investment Trends: Looking Ahead Across Equity Sectors
    China is embarking on a new stage of growth
    Gold Outlook 2021
    Shifting DC Times - Winter 2021
    GP-LED OPPORTUNITIES AT THE SMALLER END OF THE MARKET
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    pilogo-NEW
    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    150 N. Michigan Ave.
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2021. Crain Communications, Inc. All Rights Reserved.
    • NEWS
      • Asset owners and the coronavirus
      • Alternatives
      • Consultants
      • Coronavirus
      • Defined Contribution
      • ESG
      • Frontlines
      • Hedge Funds
      • Investing / Portfolio Strategies
      • Money Management
      • Pension Funds
      • People Moves
      • Private Equity
      • Real Estate
      • Searches & Hires News
      • SECURE Act
      • Special Reports
      • WorldPensionSummit
    • Data
      • Research Center
      • Searches & Hires Database
      • Searches & Hires News
      • RFPs
      • Charts / Infographics
      • Sponsored Research
      • Trackers
    • Insights
      • Opinion
      • White Papers
      • Industry Voices
      • Letters to the Editor
      • Partner Content
      • Publisher's Update
    • Multimedia
      • Videos
      • Webinars
      • Polls
      • Slideshows
      • Charts / Infographics
    • Events
      • Conferences
      • Webinars
    • Careers
    • Research Center