Alternative Strategies Important for Pension Funds

“Private equity and venture capital have provided returns well above public market equities,” says Verne O. Sedlacek, president and CEO of Commonfund, and author of the paper, “Alternatives Reality: What to Expect from Future Allocations.” He adds: “Hedge funds have provided alpha across market cycles and protected in down markets.”

Long-term asset pools, such as pension funds, have not been able to maintain their purchasing power and spending by allocating to just a mix of passively managed investments, Wilton, Connecticut-based Sedlacek adds. “Active management of long-only strategies will bridge only part of that gap. Significant allocations to alternative strategies are necessary to preserve intergenerational equity and thus fulfill the long-term obligations of institutional investors.”

In the paper, Sedlacek outlines key factors driving the success of alternative strategies:

• Once considered exotic, alternative strategies are now seen as mainstream by investors. Over the past 30 years endowments have increased allocations to equities and decreased allocations to fixed income strategies.
• Investors have been adequately compensated with higher risk adjusted returns compared to traditional strategies. Institutions that allocate capital to alternatives exhibit higher performance in comparison to those that allocate solely to traditional assets. Thoughtfully constructed portfolios including allocations to alternative investment strategies are well-positioned to continue to outperform the “traditional” 60/40 benchmark.
• Nonprofits of all types and size have significant allocations to alternatives. Today, the largest educational endowments allocate on average more than half of their portfolios to alternative investment strategies. Pension funds, while at much lower allocations, have likewise shifted assets toward alternatives in an effort to boost investment performance and dampen volatility.

According to the paper, investment manager selection is critical. There is a wide dispersion of returns in alternative investments, making manager access and selection key determinants of returns. Allocations to alternatives should be only for investors that can access top-tier managers, since the distribution of returns among alternative managers is far greater than it is among traditional managers.

The paper concludes that the fundamental principles and drivers of investment performance that have propelled returns for alternatives over the last two decades are largely unchanged. The paper also concludes that significant allocations to alternative strategies need to be “thoughtfully constructed and [overseen by] top-tier managers.”

The full text of the white paper can be found here.

Commonfund is a provider of fund management and investment services for long-term investors such as nonprofit institutions, corporate pension plans and family offices.