Asset Allocation to Alternative Investments Flashcards
What are the basic roles of private equity in a portfolio?
CG and Income generation
- Return enhancer over public equities - not a diversifier - capture illiquidity premium
- Volatility is not observed
What are the basic functional roles of alternative investments in a portfolio?
- CG’s
- Income
- Diversification
- Safety
What are the basic roles of hedge funds in a portfolio?
Really everything as hedge funds are expansive
Which hedge fund strategies would be considered return enhancers?
- L/S
- Global Macro
- Futures
Which hedge fund strategies would be considered diversfiers?
- Short bias
- Arb
- Event driven
What is the role of real assets in a portfolio?
Inflation protection in general
What is the role of timber in a portfolio?
- CG on land
- Income from Trees
- Inflation hedge
What is the role of commodities in a portfolio?
- Inflation hedge (core)
What is the role of farmland in a portfolio?
- CG on land
- Income from crops or rent
- Inflation hedge
What is the role of infrastructure in a portfolio?
- Capital gains
- income
- Capture illiquidity premium
- Inflation hedging
What is the role of commercial real estate in a portfolio?
- CG of property
- Inflation hedging
- Income from rent
What is the role of private credit in a portfolio?
- Income from direct lending
2. CG from distressed credits
What are the strengths and weaknesses of the traditional asset allocation approach?
Strengths:
1. Easy to understand
2. Relevant for liquidity and operational management
Weaknesses:
1. Diversification is not over risk factors just across asset classes
2. Obscures drivers of risk
What are the strengths and weaknesses of the risk based asset allocation approach?
Strengths:
Risk is much more integrated
Weaknesses:
Correlation to risk factors are nonstationary
How do you find a manager who only provides one risk factor?
What are the important things to consider when evaluating risk in AI?
- SD is not accurate
- Returns are chunky
- Illiquidity is a new risk
- Just because you invest today does not mean you get exposure - capital calls happen over time
For all these reasons, asset allocation that is optimal is hard to implement
What are the important things to consider when evaluating returns in AI?
- Much more variable
2. Asset class history is almost irrelevant
What are the important things to consider when evaluating vehicles in AI?
- Limited partnerships have high concentration, high minimums, and require expertise to select
- Fund of funds are less flexible and more expensive, but operationally efficient
- SMA’s - fund of one - Very high minimums - general partners have many funds they look at and can have twisted incentives (want to place goods investments in high fee accounts)
- Liquid ALTs - smaller minimums, but not a pure strategy due to regulatory restrictions
What are the important things to consider when evaluating liquidity in AI?
- How liquid is the actual vehicle?
2. How liquid is the underlying asset?
What are the important things to consider when evaluating fees in AI?
- Any extra pass through fees?
2. How are PE fees charged?
What are the important things to consider when evaluating tax in AI?
- Are the funds target investors taxable?
2. How much control do you have over taxes?
What is the suitable investment horizon for AI?
For private assets at least 15 years, for public lockups are usually at least a year.
What are the three primary approaches of determine your allocation to alternatives?
- Monte Carlo
2. Optmization
How do you use monte carlo simulations to allocate to alternatives?
- You can generate return scenarios that deviate from normality (M-CVaR optimization)
- Estimate long term risk profile
How do you use optimization methods to allocate to alternatives?
- This will typically over allocate to AI if using MVO - to limit this you must establish constraints
- You can use Mean CVaR optimization
