Financial Peace of Mind with
Institutional
Alternative
Investments

Have financial peace of mind knowing your clients’ portfolios are activity managed by institutional managers and designed to reduce volatility and diversify risk during the most vulnerable times.

April 20, 2020

Your clients' financial peace of mind is vital along with the other important things brought on by the current crisis — spending time with loves ones, working from home and homeschooling children.

In the last 40 years, we have seen a 1987 market crash, a 2000 dot com crash, a 2008 global financial crisis, and now the 2020 Covid-19 crisis. The S&P 500 erased a fifth of its value during the first quarter of the year, its worst quarterly decline since the global financial crisis. Market corrections are inevitable, and market timing is impossible.1

Research has shown that timing the markets eventually leads to lower returns than selecting a sound and diversified asset allocation and staying the course.2

More than 10 million Americans filed for unemployment in March, with virtually every industry seeing job loss, according to Department of Labor data. Meanwhile, estimates from Federal Reserve economists predict that joblessness could soar to 32.1% — higher than even during the Great Depression.3

Unemployment and hardship can lead to demoralization, depression, and other psychological traumas, lowering affected individuals’ productivity and attractiveness to employers. We saw this in the 1930s, not just in declining rates of labor force participation but also in rising rates of suicide and falling rates of marriage.4

Most investors have thankfully enjoyed a decade of steady growth, but now is the time for advisors to review how recession-ready their clients' portfolios are.

Financial Peace of Mind With Institutional Alternative Investments

For high net worth investors, the goal for an investment portfolio is typically to outpace inflation and compound at an attractive risk-adjusted rate of return that achieves capital preservation for multi-generations.

Volatility diminishes the rate at which investments grow over the long term and has a negative relative impact on portfolio returns. That said, it is imperative for portfolios not to find themselves recovering from big portfolio declines at every market correction.

The market is difficult to predict, so diversifying your portfolios with assets that are less correlated to typical stocks and bonds may be worth considering. Alternative investments aim to protect capital and steadily compound growth. They have historically delivered a smoother pattern of returns which help investors weather volatility and reach their long-term goals.

For advisors, alternative investments may also help dampen the volatility of their AuM and ultimately increase revenue. They may also increase average account sizes, resulting in improved margins, EBITDA growth and increased valuations for advisory businesses.

PE, Historically Resilient in the Face of Crisis

An analysis of median net IRRs of U.S. buyout funds across vintages confirms private equity’s outperformance during economic downturns. The Cambridge study reveals that the asset class generated some of its strongest returns in recession-year vintages, including 2001, 2002, and 2009.5

Financial Peace of Mind with PE Vintages

Source: Cambridge Associates U.S. Buyout Index, as of March 2019. 2016 is the latest vintage available. For illustrative purposes only.
Past performance is not necessarily indicative of future results and future accuracy and profitable results cannot be guaranteed.

Hedge Funds Prove Their Resilience in the Face of Criticism6

So far, amid the Coronavirus, early data on first-quarter performance suggests the average hedge fund was down about 7% for the year, while the S&P 500 lost about 20%.

If 2008 was any guide, when the S&P 500 collapsed 37%, hedged equity funds held up much better, losing just 12%. The funds then rallied 14% the following year vs. a 26.46% gain for the S&P 500. That means over this two-year period of collapse and recovery, these hedge funds did better than the market.

It is important to note that past performance is just that, and the chaos wrought by Covid-19 is different than the crisis triggered by the global metastases of defective U.S. mortgage-backed securities.

Recessions Are Inevitable and Typically Followed by Economic Strength

Coronavirus, Maybe a Boon for 2018/2019 Private Equity Vintage Funds

The timing could be fortuitous for private equity funds that are finishing up their fundraising and looking to deploy capital.

Before the pandemic hit, forecasts suggested that 2018/19 vintage funds would likely struggle to make decent returns this year as they faced record high asset pricing and intense competition. But once the markets settle down from the current volatility, vintage funds will be ideally placed to acquire portfolio companies at the bottom of the pricing curve, according to research from financial data and information provider Preqin and risk management consulting firm FRG.

While a recession certainly poses material risk to portfolio companies and exits today, it also represents a record opportunity for fund managers to buy at low prices after the longest bull market in history.7

Manager Selection Matters

Active management will play a vital role in navigating the volatility ahead, as opposed to the last decade of passive investing.

Market volatility creates opportunities over the long-term, and this is an opportune time to focus on institutional quality managers with quality assets and earnings. If your clients have committed capital to experienced, proven alternatives fund managers who have lived through deep recessions, they can take comfort in thinking the GP is prepared to react and capture value by identifying mispriced assets and attractive opportunities during this market dislocation.

By working with institutional managers, our community of advisors and their investors receive the benefits of experienced trading teams, robust technical infrastructure, tested disaster and crisis recovery plans, and the ability to trade in several markets.

It is prudent to invest with managers with a significant amount of their own money in their fund, giving them "skin in the game." If manager compensation is heavily weighted towards performance fees, this will incentivize risk taking. When managers have a substantial portion of their net worth invested in their products, this balances out the incentive to take outsized risks with a desire to preserve capital.

Market Concern is Increasing Investors’ Appetite For Alternative Assets

"In many respects March and 1Q20 reflect a sharp and volatile reversal of the risk-on environment which dominated 2019, underscoring the importance of maintaining a diversified alternatives portfolio," HFR's Kenneth Heinz said.8

Despite a slowing global economy and geopolitical uncertainty, the alternative assets industry continues to grow. In fact, according to a report from financial data and information provider Preqin, investors are doubling down on alternatives in order to provide returns in difficult times.

Assets under management grew to more than $10 trillion last year as investors poured capital into alternatives. The survey by Preqin found that 71% of investors in each alternative asset class felt performance met or exceeded their expectations in 2019. And at least 77% of investors in each asset class said they will maintain or increase capital commitments in 2020 compared with 2019. And in the longer term, at least 81% said they will keep or raise their allocations.9

Percent of Investors with Financial Peace Of Mind

81%
of investors will raise allocations
to alternative investments

NY State Pension invested $2.7 Billion in alternatives just before the market tanked. The $210.5 billion fund invested more than $2.2 billion in private equity and no money in public equities.10

Conclusion

Institutional alternative investments may help your clients' portfolios diversify from traditional stocks and bonds and reduce overall portfolio volatility. They have historically delivered a smoother pattern of returns which helps portfolios weather volatility and reach their long-term goals — adding that essential peace of mind to during the most vulnerable of times.

  1. CNBC. ‘Once in a decade’ opportunity: Financial experts’ advice for investing in the market downturn. April 1, 2020
  2. US News. How to Prep Your Portfolio in a Recession. April 1, 2020.
  3. WSJ. U.S. Jobless Claims Soar for Third Straight Week. April 9, 2020
  4. Financial Advisor Magazine. The Human Capital Cost of the Crisis. April 10,2020
  5. Cambridge Associates U.S. Buyout Index, as of March 2019. 2016 is the latest vintage available. For illustrative purposes only.
  6. WSJ. Hedge Funds Defensiveness Finally Pays Off. April 5, 2020.
  7. Chief Investment Officer. Coronavirus a Boon for 2018/2019 Private Equity Vintage Funds. April 6, 2020.
  8. Pensions & Investments. Hedge fund performance down sharply in the first quarter. April 8, 2020.
  9. Chief Investment Officer. Investors ‘Double Down’ on Alts Amid Market Turmoil. March 19, 2020
  10. Chief Investment Officer. NY State Pension Invested $2.7 Billion in Alts Just Before Market Tanked. April 3,2020.

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