Monday, November 11, 2013

More Signs of Caution on Alternative Investments

More Signs of Caution on Alternative Investments

As alternative investments continue to make inroads with public pension plans and retail investors, evidence is continuing the pile up that this headlong rush isn’t a very good idea.  In just the last week, I’ve seen a series of stories that ought to make pension trustees and individual investors pause before they add yet more to their hedge fund and private equity allocations.

The National Association of College and University Business Officers (NACUBO) and the Commonfund Institute just reported that university endowments decreased their allocation to alternatives from 54% to 47% in year ended June 30.[1]  In other words, the pioneers in alternative investments are reducing their exposure at the very time that the less sophisticated are stepping up to these asset classes.
Ramp Up (1999)
Moreover, NACUBO and the Common Fund reported that universities relying most heavily on conventional stocks and bonds instead of alternatives generated the best three and five year returns.  James Stewart explores these results in The New York Times in “Fast Growing Endowments, Without Ivy.[2]  While endowments with a high concentration of alternatives still sport better 10-year returns, those numbers reflect a period when there was far less money chasing alternatives.

Bloomberg reports that the Endowment Fund, a fund of funds designed to replicate the endowment model for wealthy folks, is being forced to sell $1.8 billion in alternative assets via a secondary sale in order to meet redemptions.[3]  I wrote about the problems at the Endowment Fund over a year ago in “Overweight Duck:  The Laden Version of the Endowment Model [October 30, 2012].”  Apparently a change of Chief Investment Officers didn’t do much to stem the tide, and now the fund is being forced to prematurely sell positions in order to allow its investors to cash out.  There’s a terrible irony in watching an investment that was supposed to bring peace of mind to investors turn into a nightmare.

Finally, we have sobering words from David Swenson, CIO at Yale University and the founder of the endowment  model.  Speaking before a small group at Yale, Mr. Swenson is reported to have said, “integrity is central to investment management. But the current culture surrounding finance is defined by money. Reputation is no longer emphasized.”[4]

Mr. Swenson has hit upon a key problem and the inspiration for my blog taken from 1 Timothy 6:6-10, “In their eagerness to be rich some have wandered away from the faith and pierced themselves with many pains.”  When an investor decides to enter the world of alternative investments, the need to evaluate the integrity of the manager escalates dramatically.  Conventional stock or bond managers traffic in transparent, commodity-like products.  While you’d always prefer your manager to have integrity, there are legal structures to prevent him from doing irreparable damage and easy options to terminate your relationship with him.   When you hire a private equity, real estate, or hedge fund manager, even the best-drafted legal documents won’t insulate you from major trauma if the manager lacks integrity.  The flood of money represented by public pensions and retail investors is a magnet for the types of money managers that Mr. Swenson sees dominating the industry.  It’s no wonder that thoughtful investors have grown more cautious of alternative investments.


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