Markets & Economy
Considerations for alternative investments
August 15, 2014
Amy Chain: Hi, I'm Amy Chain at Vanguard. Welcome to today's program, where we'll be discussing the role of alternative investments.
Some university endowments and other large institutions have been successful using alternative investments, whether as a way to boost return of their portfolio or as a further source of diversification.
Joining us to look deeper into alternative investments and their role in the portfolio are members of Vanguard's Global Investment Strategy Group.
Thanks, everyone, for being here today.
Panelists: Thank you. Thanks, Amy.
Amy Chain: Alternative investments as an asset class seem to cover a lot of territory, from hedge funds that today manage more than $2 trillion, and private equity to real estate and commodities.
Jeff, let's talk about how to define these investments.
Jeffrey Johnson: Thanks, Amy, so alternatives is a big, broad category that can mean a lot of different things to a lot of different investors. We typically would think of them as being hedge funds, private equity, or other private real assets. But ultimately our view is that they're really private, actively managed forms of accessing five traditional asset classes: stocks, bonds, cash, real estate, and commodities.
Now, some investors have been pretty successful in this space, to your point, but they're investors who have been able to overcome some of the complications associated with investing in alternatives.
Amy Chain: Let's spend a minute on that. I think that there are probably some commonalities among institutions that have been successful using alternative investments. Let's talk about what some of those considerations might be.
Jeffrey Johnson: Sure. In order to be successful in the alternative space, there's probably three things that you have to bring to the table. One, you have to have the expertise; you have to have the deep team of experienced investment professionals who know how to access these various markets.
The second thing is, it's pretty important to have size, which affords you pricing power in the space. Costs can be particularly high when investing in alternatives, so being able to drive those down as far as you can is critically important.
And third, having the access to the top managers or the direct investments themselves is a third ingredient of success.
Amy Chain: Now, Catherine, I'd love to hear from you. Let's talk a little bit about what investors should be thinking about if they are interested in investing in alternative investments.
Catherine Gordon: I think the first thing is, unlike having a strategic asset allocation to the traditional asset classes—how much in stocks, bonds, cash, real estate, commodities, however people define those—an allocation to alternatives really is, it's not a top-down decision, it's bottom-up. It's an active decision; it's a manager selection decision. So you really have to have the confidence that you and your team have the ability to identify those managers in advance who will likely deliver the returns that your portfolio is looking for.
So it's a very—it's as difficult as finding, you know, successful active managers in advance, as difficult as that is. It's extremely difficult in the alternative space just because of the size of the number of options.
Joel Dickson: If you think about the due diligence process involved in all of that, it's often multiple times more complex than the due diligence that you do on a traditional active manager. And not just due diligence of the underlying managers, but also the portfolio management considerations that you, as the investor in alternative strategies, may have. Because you may have capital calls at various times; you may get your money locked up. And if you get an event where you need some liquidity in your portfolio, it may be very hard to get that out of your alternative investments because you haven't had a distribution, for example, of that cash.
So there are a lot of additional complications there that need to be taken into account when thinking about the opportunity there.
Francis Kinniry: And you had mentioned in the early part endowments and foundations, and Jeff went through some of the criteria. So the endowment and foundation universe is some of the most sophisticated investors who have access, who have pricing power, who have deep teams. And I think what happens is we always celebrate the top, so you read in the newspaper: "Endowment X, Y, Z, Foundation A, B, C outperforming the market."
You know, you have to ask yourself: Do you have the same competitive advantage as some of the largest, most sophisticated endowments and foundations, and that ability to do due diligence, get access, and get that pricing power?
Amy Chain: That's a great summary, Fran, thank you. I'd like to thank you all for being a part of this conversation, and thank you for watching us today.
For more about Vanguard's perspective on alternative investments, check out our website.
All investing is subject to risk, including the possible loss of the money you invest.
Diversification does not ensure a profit or protect against a loss.
Past performance is no guarantee of future returns.
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Conversations with Vanguard Global Investment Strategy Group
The success some endowments and foundations have had with these investments can be hard to replicate.
In this short video, a panel of international experts from Vanguard's Investment Strategy Group discusses what investors need to bring to the table to be successful in this space.
Also of interest:
- All investing is subject to risk, including the possible loss of the money you invest.