“It’s a big world out there.”
A salient observation in its own right, and the title of a Tuesday morning session at IMCA’s national conference in National Harbor, Md., but it’s even more so when trying to comprehend alternative investments and their role in the client portfolio.
Presented by Chris Cesare of Rocaton Investment Advisors, the session was broken into three parts to help advisors in the audience digest what is too often an overwhelming task: evaluating appropriate alternative managers and products. The three parts were a review of alternative investment strategies (including management and structure of the investment vehicle), a discussion of why advisors should even bother with alternative investments and, lastly, the role of proper due diligence in the selection of a product.
Cesare began by defining the alternative investment universe, which he said contains 7,000 hedge funds, 1,800 private equity funds and 500 real estate and infrastructure funds.
“How should you think about the alternative investment universe?” he asked. “”It’s similar to how a scientist considers the galaxy. There’s been a lot of press lately about zones of life that might support something like ourselves. It’s the same with the appropriate zone for alternative investments within the portfolio.”
But, he warned, there is a large range of potential outcomes; the potential for great returns, and also the potential for great embarrassment with clients when a “down draft” occurs, which is why the evaluation of the alternative product’s manager is so critical.
Cesare then offered up 10 pitfalls that could result in an unpleasant outcome when employing alternative investments:
1) The famous “2 and 20” fee structure will always apply, even if returns are mediocre, something that’s exacerbated in the alternative space.
2) The management team leaves for another shop after due diligence has been performed
3) The wrong strategy is employed at the wrong time
4) The right strategy is employed at the right time, but the manager has the wrong implementation
5) Risk (mis)management
6) A mismatch occurs between the product’s assets and liabilities