“There’s a lot of potential for selection success and for selection error,” he said. “If you pick the wrong one, you don’t get diversification.”
And that’s why it pays to know how to better evaluate alternative investment opportunities. Kerry Jordan, marketing director and chief compliance officer at Chicago Capital Management, said aspects to consider when doing due diligence on an alternative product manager include the firm’s performance track record; how long the management team has worked together; and how the manager and his staff identify investments to put into their portfolio.
“That’s very important in terms of their ability to continue to generate consistent returns,” she said.
Jordan noted that style drift can be a problem for certain alternative managers Some hedge funds, she said, shift from their stated strategy when it fails to produce alpha as the markets change. “That can produce a mishmash of returns that generally aren’t representative of a dedicated style.”
Among the intangibles to look for, Jordan added, is the manager’s passion. “You want to have someone who’s truly consumed by the trading style that he’s doing and is dedicated to it,” she said.
Gabriel Burstein, head of investment strategy at Curian Capital, offered that alternatives shouldn't comprise more than 20 percent of a client’s overall portfolio.
As part of that alternatives sleeve, he recommends roughly three-quarters of that should be devoted to alternative strategies such as long/short equity, event-driven and global macro. “On the whole, that’s the [alternative] portfolio’s core,” he said.
Other investments could be placed in areas such as commodities and real estate, which Burstein describes as alternative assets.
The difference between the two is that alternative assets are more correlated to the overall market than alternative strategies. Those alternative assets can provide some upside when the equity market is on roll, he said, but they are three to four times more volatile than alternative strategies that are designed to provide less correlation to traditional stocks and bonds.