Winners and Losers in Alternatives

Which alternative assets provide true diversification and outperformance? And which aren’t worth the fees?

Hedge funds, private equity, real estate—which alternatives are actually worth the investment?

Alternatives as a whole have underperformed equities since the financial crisis—but “not all alternatives are created equal,” argued PGIM’s Harsh Parikh and Tully Cheng. To make successful allocation decisions, they continued, investors need to consider alternatives at a “more granular level.”

Parikh and Cheng broke down the performance of the various subcategories within alternatives from January 2000 to March 2015 to determine the alpha and beta exposures of each.

“Many alternatives are exposed to a variety of market betas,” they wrote. “While some of these exposures may have a place within total portfolio construction, others might be more efficiently accessed, at more reasonable fees, elsewhere.”

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Some of these high beta strategies included funds of funds and equity hedge strategies, which “demonstrated a high level of explainability, relatively stable factor weightings, and lower alpha.”

The highest alpha-producing alternatives were core real estate, value-add real estate, opportunistic real estate, and leveraged buyout private equity. Significant alpha was also observed in event-driven, macro, and relative value hedge fund strategies.

However, given the “outsized dispersion” among managers, Parikh and Cheng warned that manager selection remained “essential.”

“There are certain strategies that appear have delivered significant alpha as well as attractive diversification characteristics,” they concluded. “Others… might not, on average, contribute much to one’s overall portfolio.”

PGIM alternatives exposures Source: PGIM’s “Revisiting the Role of Alternatives in Asset Allocation

Related: The Most Consistent Names in Alternatives & NJ Pension: Alts Are ‘Worth It’