How to Run Alt Investments: A Primer | Chief Investment Officer

Alternative investments have become very popular among asset allocators, many of whom are seeking diversification after a rocky 2022 for traditional investments, namely stocks and bonds. Among public pension plans, alts are now more than one-third of assets, often managed through limited partnership funds.

Given the swelling popularity of alts, the Alternative Investment Management Association Ltd., the asset category’s trade group, has come up with a list of how-to tips for alt fund managers, ranging from dealing with valuation problems to ESG challenges. These suggestions are necessary to advance “sound practice excellence for managers,” according to a report from the AIMA’s global investor board, chaired by Eduard van Gelderen, the CIO at Canadian pension manager PSP Investments.

Alts encompass disparate approaches from the likes of hedge funds, private equity, private credit, venture capital and real estate, but common best practices prevail for all, the report found.

For one thing, alt fund managers should consider banding together and sharing costs—which magnify their clout and expand their knowledge, the report recommended. Also, it said, managers should detail “what the fund is actually doing and be upfront about how the fund may be similar or different to competitor funds.”

The report urged that funds view their portfolios “holistically,” meaning how they stack up against other investing techniques. So, for instance, investors in private assets should compare their risk, performance and diversification with publicly traded assets.

In light of controversies surrounding environmental, social and governance investing, the study argued that ESG-oriented funds should better explain what they are doing. The implication was that too often they fail on this score because of the “thorny” difficulty “of squaring their fiduciary duty to their underlying investors with a desire to do good.”

The report added that there “is no need to be all things to all investors, but being honest, authentic, and intentional about your approach to ESG” has the best chance of minimizing frictions.

For hedge funds, the study applauded the trend toward lower fees, once 2% for maintenance and 20% for managers’ incentive payments, and the advent of “hurdle rates” to determine incentive payouts.

For private equity, which had a sterling 2022 when other investments flagged, there’s a danger that many now view them as over-valued. To combat this perception, the report declared, PE managers should be “much more transparent” in how they arrive at asset values for their non-public holdings.

Nonetheless, the “denominator effect is real,” the study stated. This is the tendency to value private assets more highly than public ones, whose prices have tanked. PE managers must expect that investors may slow their commitments to the funds “for the next year or so,” leery about over-paying for stakes in PE vehicles.

Meanwhile, the report said, funds launched in 2023 and 2024 will fare better, as suspicions over their values will be muted because they are priced in sync with current public market values.