Alternative Investments

A Prudent Approach to Alternative Investments

The inclusion of alternative investments in a well-diversified portfolio offers the opportunity for enhanced returns without an increase in risk.

A significant portion of risk in seemingly diversified portfolios is often attributable to correlation with the broad U.S. equities market.

For this reason, adding certain alternatives such as less directional hedge funds, real estate and commodities, which tend to have low or negative co-movement to the stock market, offers the opportunity to capture “structural alpha,” i.e., return in addition to equity based return or “beta.”

  • Our experience — since we first began investing in alternatives in 1991 — has shown that they need to be evaluated in the proper framework to ensure that reported excess return is consistent with the investment strategy implemented and not the result of unintended risk exposure. When evaluating funds with limited liquidity, we take care before committing capital and adjusting our exposure. In particular, we seek to avoid funds with excessive leverage, significant illiquidity, or concentrated positions that could result in a worse than expected outcome.

  • When constructing portfolios with allocations to alternative investments, we initially determine the weighting to alternatives and then use a reverse allocation methodology to build the portfolio around them. Because alternatives are typically illiquid, and in some cases involve capital calls, we start with this allocation to ensure our clients’ liquidity needs are maintained. We then apply optimization techniques to round out the portfolio, creating a strategic asset allocation.