The role of Alternatives

A performance analysis on alternatives over 15 years conducted by PGIM

 

REVISITING THE ROLE OF ALTERNATIVES IN ASSET ALLOCATION

https://www.pgim.com/wps/wcm/connect/ec44ffeb-67ac-46b1-943f-8e3fdcf668d8/IAS-Alternatives-WP.pdf?MOD=AJPERES&CVID=loIAcq3&CVID=loIAcq3&CVID=loeQU-N&CVID=loeQU-N&CVID=lo9JokU

 

Through March 2009 ~ December 2015, US broad market equity indices returned more than 200%, far surpassing the gains made in most alternative strategies

some large public pension systems in the U.S have recently been trimming their hedge fund exposure.

スクリーンショット 2016-08-01 18.25.14

History

In the late 1980s, David Swensen in Yale pioneered the “endowment model”

Through strong manager selection and reallocation from traditional assets to alternatives, Swensen successfully generated outsized returns, prompting others to follow suit.

Minimal disclosure requirements and specialized investment mandates (that allow illiquid assets, leverage, short-selling, derivatives, and esoteric assets) provided the alternative managers a unique way to exploit market inefficiencies

Private equities to offer attractive risk-adjusted returns albeit with a high risk target and a long lock-up period.

Real estate to provide meaningful diversification to a portfolio with the stipulation of possible cyclical returns.

Hedge fund strategies, such as event-driven and relative value, to improve diversification and lower drawdown risk while generating robust alpha.

 

Performance and Diversification

This paper analyzed the role of these alternatives from the beginning of 2000 to Q1 2015 representing two full market cycles

スクリーンショット 2016-08-01 21.51.32

venture capital’s poor performance and large volatility stands out

equity hedge and fofs underperformed fixed income, which enjoyed strong performance over this sustained declining rate environment

alternatives, except for VC, produced better risk-adjusted performance than equities over the period studied

スクリーンショット 2016-08-01 21.52.05

 

macro and relative value had the lowest risk and drawdowns amongst alternatives over the period

スクリーンショット 2016-08-01 22.09.05.png

many alternative strategies, on average, have significant exposures to market betas. In contrast, real estate and macro hedge fund strategies offer better diversification.

almost all of these strategies had negative correlations to fixed income, given the strongly negative correlation between the US Aggregate and the S&P 500 (-0.36)

スクリーンショット 2016-08-01 22.17.22.png

macro hedge funds exhibited low correlation to equities during periods of stress such as during the height of the financial crisis

 

Beta or Alpha?

スクリーンショット 2016-08-01 22.19.25.png

returns of fofs, equity hedge, and event-driven hedge funds can to a large extent be explained by market beta factors (high R-squared values)

significant equity, size (small cap), and emerging markets factor exposures, which may explain the drawdowns these categories experienced during the financial crisis

real estate, as well as leveraged buyout private equity, had low exposures on market factors and owned the highest alpha (intercept)

real estate: active management and high current income
LBO: active management and management of distributions

スクリーンショット 2016-08-01 22.47.43.png

many of the hedge fund strategies generated stronger alphas in the earlier, as opposed to later years

macro demonstrated very strong countercyclical surges in alpha following both equity market downturns, shifting to a period of negative alpha only over the most recent period

 

Portfolio Construction

スクリーンショット 2016-08-01 22.54.41.pngスクリーンショット 2016-08-01 22.58.37

the introduction of 20% selected alternatives strategies (replacing equity) reduces realized volatility and dampens the maximum realized drawdown

the “risk-off” bucket is marginally more effective

スクリーンショット 2016-08-01 23.15.15.png

Investors should carefully consider the nature of the exposures that they are taking on, particularly within the context of their own objectives

the additional credit weighting might be an unintended result.

Additional Considerations

outcomes may vary significantly even within a subcategory and fee structures where alternative fee structures might evolve to better align investor and manager interests.

スクリーンショット 2016-08-01 23.25.35.png

Manager selection is critical, given the wide performance dispersion observed across many types of alternatives

 

Advertisements