Managing Complexity Can Improve Returns in Alternative Investments According to 2011 Greenwich Roundtable Paper
GREENWICH, Conn., Nov. 22, 2011 /PRNewswire/ — The Greenwich Roundtable today released a white paper describing how investors can manage complexity of alternative investments to improve their returns.
The Greenwich Roundtable is a leading not-for-profit research and educational organization comprised largely of institutional investors overseeing collectively $2.2 trillion in assets.
The research paper focuses on understanding the many and varied risks involved in hedge funds and private equity, and describes the best practices and due diligence steps that investors need to pursue to manage those risks. The white paper also explores the complexity of volatility, leverage, and liquidity and how these factors together can compound risk.
“Complexity and volatility are the norm for investors, as today we seem to have a 100-year financial storm about every three years or so. As a result, returns for the decades ahead are almost assuredly going to look much different,” said Steve McMenamin, executive director of The Greenwich Roundtable. “Those investors who can manage volatility and understand the complexity embedded in their portfolios will continue to be the long-term winners.”
The major insights described in the white paper include:
- The cost of alternatives strategies is the complexity they add. The benefit is the ability to source returns from a broader spectrum of opportunities.
- Correlations matter, and they vary through time. Investors must try to understand the changing nature of relationships across their portfolios.
- Investors need to understand how each manager approaches leverage and evaluate the appropriateness of the amount and duration of that leverage.
- Liquidity is dynamic. It changes as markets change. This calls for ongoing due diligence and manager monitoring, including stress tests and projections with ample wiggle room.
“Each investor must decide whether it is adequately prepared to invest competently in alternative investments,” said Rusty Olson, former director of pension investments for Eastman Kodak Company and editor of this year’s research paper. “This paper is intended to help investors make that judgment knowledgeably.”
This is the sixth in a series of white papers on Best Practices in Alternative Investments published by The Greenwich Roundtable. This new research paper reflects the thinking of a highly diverse group of contributors who have extensive investment experience. Co-chairmen of the education committee responsible for the research paper are Mark Silverstein, chief investment officer of Endurance Specialty Holdings Ltd., and Ed Barksdale, CEO of Federal Street Partners.
The research paper is written for all investors – endowments, foundations, pension funds, sovereign wealth funds, funds of funds, and private individual investors.
Information about obtaining copies is available at www.greenwichroundtable.org.
Themes from the “Managing Complexities” White Paper
- The objective of any risk management measure is not to predict future events, but to understand the vulnerabilities that your current portfolio is exposed to.
- Leverage is not a proxy for risk. It either amplifies or dampens volatility.
- Many believed that diversification failed during the financial crisis. But the implementation of diversification failed, not diversification itself. In 2008 many investors ignored the potential severity of unexpected volatility compounded by leverage and reduced liquidity.
- Volatility is the beginning of complexity, even in the simplest portfolio.
- There is no single measure of volatility that doesn’t have crucial caveats.
- Dealing with the long term in the face of volatility is emotionally, physically, and psychologically extremely hard.
- We need to accept volatility. We can’t realistically expect to create portfolios that are not volatile. Let volatility work for you. Uncertainty creates periods of opportunity.
- We must expect the correlation of most assets to converge near one when many investors seek to reduce risk at the same time.
- Many investors trade too much, pay high fees, and time their investments poorly as they chase past returns.
- For asset allocation, some investors use efficient frontier algorithms, others use environmental scenario testing. In either case, the allocation is no better than the assumptions upon which it is based.
- “Investors need to understand that if they wish to outperform their peers, they must leave the comfort of the crowd,” said Peter Bernstein, noted financial author. “Alpha means that you risk being wrong, being alone, and having much higher volatility. If you’re not lonely, you’re probably not a contrarian.”
SOURCE Greenwich Roundtable