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The Allocation Dilemma for Alternative Investments

New York (HedgeCo.net) By most indications, investors and advisors alike have increased their use of alternative investments since the financial crisis in 2008. The evidence is pretty clear given the growth in alternative mutual funds. According to a report in InvestmentNews from May, “The amount of assets in alternative mutual funds grew from $76 billion at the end of 2009 to more than $311 billion at the end of 2014.” A recent Morningstar report showed that the assets invested in smart beta or strategic beta funds grew from $396 billion to $497 billion in the last year. The report cited growth in usage from investment advisors as one of the items fueling the growth, stating that 68% of advisors that use ETF products are integrating smart beta products in the portfolio construction of clients.

While investors and advisors are using the new alternative products at their disposal, there seems to be some disagreement on how much of a portfolio should be allocated to alternative investments. A recent white paper from clearing firm Pershing shared the results of a survey they conducted among advisors. From the perspective of the alternative investment industry, the results of the survey have to be encouraging. The survey found that nearly 75% of advisors are using alternative investments in their portfolio construction and of the advisors currently using alternatives, 73% of their clients have at least one type of alternative investment in their portfolio.

Where there seems to be the most disagreement among advisors is how much should be allocated to alternatives. The Pershing survey showed that 55% of the advisors that use alternatives think the proper allocation for the asset class is between 6% and 15% while 27% think the proper allocation is between 1-5%. Meanwhile in a CNBC article last week, Ed Butowsky, managing partner of Chapwood Investments, was quoted as saying that as much as 30 percent to 35 percent of a portfolio should be allocated to alternatives. “No matter how big your portfolio is, you need to invest in alternatives in order to have a non-correlation to the market,” he said. “If you don’t have alternatives, you don’t have the appropriate risk metrics.”
The same CNBC article also quoted Dick Pfister, CEO and founder of AlphaCore Capital. Pfister was in agreement with Butowsky that alternatives should been in all portfolios.

The article pointed to the financial crisis as a specific event that may have awakened investors to the need for alternative investments and that many people came to realize that they may not have time to recover from another 50% decline with Pfister adding, “More and more people have been turning to the alternative world to find a solution.”

Yet another article released last week from InvestmentNews featured quotes from Cliff Stanton, chief investment officer at 361 Capital, and T.P. Enders, managing director and head of the portfolio strategy team at Goldman Sachs. “It’s pretty easy to make the case that alternatives should be at least 20% or 30% of a portfolio, but we know that those kinds of allocations are rare, but at the same time, just dipping a toe in the water with a 5% allocation to alternatives really isn’t going to help,” Stanton stated. While Enders added that, “For a moderate-risk portfolio, one could make the case that many traditional 60-40 portfolios could include a 20% allocation to alternatives.”

Enders added that, “But for a client that has never invested in alternatives before, it will be difficult to get him or her to 20% in alternatives overnight. In our view, it’s pretty hard to make a case that anything less than 5% in alternatives will have an impact on a portfolio, but in order to get to the answer of how much you need in alternatives, you have to start with the idea of what they are supposed to do for you.”

With such a wide discrepancy between what some experts think is an appropriate allocation to alternatives and what advisors say they are currently allocating to the asset class, we thought it would be interesting to look at the two Ivy endowments we discussed on last week’s article Use of Non-Traditional Portfolio Tools Increases to see what their allocations were

According to the book, The Ivy Portfolio by Mebane Faber and Eric Richardson, in 2007 the Yale endowment had 19% allocated to private equity funds and 23% of the portfolio allocated to hedge funds for a total of 42%. For the Harvard endowment, the book showed the percentage allocations for both 2007 and 2008. In 2007, the endowment had 13% of the portfolio allocated to private equity funds and 17% allocated to absolute return and special situation funds. In 2008, it was 11% in private equity and 18% in absolute return and special situation funds. So 30% was allocated to alternatives in 2007 and 29% was allocated to alternatives in 2008.

This just goes to show how much of a challenge it is to determine the right allocation to alternatives. While two of the most successful investment accounts over the long run allocate 29, 30 or 42% to alternatives, 72% of advisors are allocating 15% or less to alternatives. Yes there are major differences between asset allocations for individuals versus a never-ending account like an endowment. However, what this suggests is that perhaps advisors need to up their allocations to alternatives a little.

While HedgeCoVest is part of the alternative industry and may be a little biased toward a heavier allocation to alternatives, we do believe that alternatives are only part of the total portfolio allocation model. Whether you are an individual investor or an advisor, we can help you meet the needs for alternative investments in your portfolios. Our platform offers 33 different models to choose from and we provide you with as much information as possible to help you choose which model or models would be right for you or your client. We do the due diligence for you and we provide complete transparency and instant liquidity. Quite simply, HedgeCoVest tries to make it as easy as possible to incorporate alternative investment strategies into investor portfolios.

Rick Pendergraft
Research Analyst

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