As public markets fluctuate wildly from China to Europe to Wall Street, consider the appeal of alternative asset managers, including private equity, venture capital, hedge funds, REITs, commodities, infrastructure and other asset classes. But, before you make an investment, there are several important questions you should ask.
But compared to past decades, alternative managers in the 21st century face steep hurdles to provide alpha -- risk-adjusted relative performance - for investors. When considering alternatives, investors should carefully consider how exactly these asset classes add value, whether they still do, and whether they have potential to do so in the future.
The second half of the 20th century was of great importance in the history of global investment management, as alternative asset classes and independent managers produced sophisticated, innovative products, and attracted a great number of clients, often at significantly higher fees than before. Many firms produced great rewards for investors and managers alike.
However, the long investment history indicates that it is probably not possible to devise a single superior investment technique that works era after era. Like so many important innovations in the history of investment and investment management, competition and changing market conditions moderate high performance rates.
The savviest investors ask themselves a few important questions when it comes to alternative investments. Consider the following:
Are you getting a premium if there is illiquidity?
Alternative investments are often less liquid than a traditional asset class: stocks, bonds and cash. When institutional investors like Yale University's endowment and the Oregon Investment Council began to move into less liquid alternatives in the 1980s, they found that these strategies offered an enormous premium for their relative illiquidity. In exchange for parking their assets in these vehicles, investors could receive sizable incremental returns.
However, this characteristic of alternative investments is no longer guaranteed. The institutionalization of private equity, venture capital and other alternative investments means that illiquidity, in and of itself, no longer necessarily generates stronger returns.
When it comes to liquidity, there is no silver bullet; an investor should not be either liquid or illiquid, as such. A given market participant should instead be aware of how much he or she needs liquidity, how much it costs, and how much it will return in a given investment scenario.
Are the fees worth it?
The standard fee structure for the alternatives market is known commonly as "2-and-20": managers often charge 2% of assets under management as a management fee and 20% of profits generated by their investments as a performance fee. A.W. Jones, the creator of the first hedge fund, charged his clients this based on the fees charged by ancient Phoenician ship captains for profits on successful journeys.