7. Terms—the best alternative investment strategies have a fee structure that is aligned with both the money manager (i.e., general partner) and the investor (i.e., limited partner). These managers are mostly compensated for consistently generating outsized absolute and relative performance. If management fees represent a significant amount of the manager’s total compensation, it may reduce the incentive for the team to generate strong returns. So, it is important to identify this issue at the onset before any allocation is made.
If each of the following criteria are met when researching an alternative investment manager, then the probability of identifying a top-quartile strategy is high. It is important to consistently stay in contact with manager, build a relationship, and learn about the strategy’s performance, team, and opportunity set. These tasks are accomplished through on-site due diligence visits, research calls, and ongoing conversations. Unfortunately, there are times when successful teams may break up or a strategy may diverge from its core investment competency. At that point it may make sense to reevaluate the manager and determine whether an allocation going forward is adequate.
Alternative investing has become mainstream and transitioned from optional to an essential part of portfolios. Adding to different asset classes such as hedge funds, private equity, private debt, real estate, and real assets should improve the risk and return profiles of portfolios, especially relative to a more traditional equity and fixed income portfolio mix. It is vital, though, that the alternative strategies that are implemented are top tier and have outstanding qualitative and quantitative characteristics. Otherwise, investors will suffer and miss out on opportunities that are currently not heavily available in the public markets.
Source; Lipper, NCREIF, Cambridge Associates, HFRI, J.P.Morgan Asset Management, Data is as of August 13, 2021.
Source: HFR, HFM, Capital Solutions, Barclays
Sloan Smith is principal and director at Innovest.
