Alternative Investment trends to watch out in 2017

Alternative Investment trends to watch out in 2017

"2017 is sure to be a year marked by less central bank intervention, higher interest rates and increased volatility"

William Kelly
The Alternative Investment industry has experienced dramatic growth over the last twenty-five years, with a substantial amount of the institutional flows into this space just in the last decade alone.  While this has mostly been a good thing, 2016 has not felt like a year of accolades for this part of the capital markets. One of the most widely reported statistics has been investment performance which in the recent period, has been low in both absolute terms and also relative to expectations, even though some holders of this latter view are a bit misguided.  Why is this, and how can our industry reset the tone and expectations?

There are now over 10,000 hedge funds globally with about $3 trillion of AUM; what was once (maybe) an asset class is now a very broad collection of very different strategies.  The return profiles of the top performing so-called hedge fund managers versus the ones at the bottom are separated by absolute differences of close to 40% (i.e. best investor return is +20% and the worst is close to -20%) over the last ten years.  Correlations to equity indices, on average, are trending up which calls into question the essence of the value proposition of alternatives in the first place.  In the Private Equity space, we have gone fromjust 24 general partners in the 1980s to over 6,600 today and, by some estimates, there is over $1 trillion of dry-powder looking for the next great investment.  Here too the dispersion of returns from best to worst is widening and the compensation for the illiquidity premium has narrowed substantially.  Fees and lifestyles, fairly or unfairly, are under constant attack by the media, and global regulators continue to look for ways to reign in leverage and liquidity rules that can actually be risk mitigators when deployed in the appropriate way.

2017 is sure to be a year marked by less central bank intervention, higher interest rates and increased volatility.  These are all generally very good inputs for alpha seeking managers, however, the value proposition for alternatives should never be viewed as cyclical, even though many products have been sold that way.  The old statement that "the only free lunch left in investing is diversification" is still alive and well.  Having a portfolio allocated across multiple and uncorrelated risk premia should be a perpetual mantra, coupled with the fact that no one can consistently time market peaks or valleys. Our industry should embrace a New Year's resolution to be more transparent about investment process, portfolio fit and performance expectations, and became a provider of long term solutions versus a purveyor of the current hot product.

Education will also continue to be very important.  More and more mass affluent and other retail oriented investors will be entering the brave new world of alternative investments in 2017, many for the very first time.  Investment reward cannot come without the assumption of some level of risk.  The true value proposition for alternatives is the role that they can play toward providing better risk adjusted returns over the long run, even though the less sophisticated investor seems to view these products as high risk and high return.  Those latter type of products (note I didn't say solutions!) are available too, but will be exceedingly volatile and will likely singe one's fingers, along with the allocator's long term goals,  well before they deliver upon those misguided expectations.

Alternative investments remain a tiny fraction of the global investable pie.  There should be tremendous opportunity and need for these asset classes in 2017 and beyond, but closer communication and cooperation among asset managers, asset owners, regulators and the media will be essential for this sturdy stool to withstand the test of time.

By, William Kelly, CEO, CAIA Association