Institutional Investing: Harnessing the Power of Alternative Assets

Institutional investors, generally comprising of pension funds, foundations and endowments, play an important role in the financial markets. Traditional investments like stocks and bonds remain foundational to portfolios like these, and in addition to these foundational investments, many institutional investors turn to alternative assets to enhance portfolio diversification in pursuit of higher returns. While no past performance can guarantee future results, I do want to explore the world of alternative assets (alternatives) within institutional investing and how alternatives can be harnessed to achieve investment objectives.

1.Definition of Alternative Assets

Alternative assets encompass a wide range of investment opportunities beyond traditional stocks, bonds, and cash. A traditional definition of an alternative investment is a financial asset that doesn’t fit into the conventional equity/income/cash categories.1 These may include private equity, hedge funds, real estate, commodities, infrastructure, even crypto, etc. However, many of these traditional definitions of alternative investments may give you even more exposure/correlation to the asset classes one is trying to diversify away from. By diversifying into alternative assets, one truly needs to understand what the underlying investments are and if they are in fact diversifying away from equities and fixed income.

2. Diversification Benefits

One of the primary reasons institutional investors allocate funds to alternative assets is to augment diversification. Unlike traditional assets, alternative investments often have low correlation with stock and bond markets.1 This means they can potentially provide valuable diversification benefits. The misconception about alternatives is that they are generally considered to be higher risk investments, and therefore have the potential to drive higher returns.1 Mainly, they increase the investment opportunity set thereby widening the aperture for investors to consider where to place their funds and to consider long-term goals. All with the ultimate aim of enhancing their efficient frontier, where return is optimized for every given level of risk.

3. Risk and Return Profiles

Alternative assets come with varying risk and return profiles. They generally have limited accessibility and liquidity, and frequently come with higher fees/expenses than traditional investments.1 For example, investments in private equity and venture capital typically offer higher return potential but also come with increased risk and longer investment horizons. On the other hand, real estate and infrastructure investments may provide stable income streams and capital appreciation potential with lower volatility. None of this is set in stone, to be sure. Your dedicated investment advisor can offer you advice.

4. Access and Liquidity Considerations

Investing in alternative assets often requires specialized knowledge and access, which is why it is always helpful to utilize an investment advisor you trust, and one who is fiduciarily bound to the financial health of your fund or pension. These investments may have longer lock-up periods and lower liquidity compared to publicly traded securities. Institutional investors must carefully consider the liquidity needs of their portfolios when allocating to alternative assets. And again, work with an investment advisor you trust.

5. Due Diligence Process

Conducting thorough due diligence is paramount when investing in alternative assets. Institutional investors must evaluate factors such as the track record of fund managers, investment strategies, fee structures, business risks and regulatory considerations. Rigorous due diligence helps mitigate risks and keep you informed. Typically, institutions do this through processes which invite multiple groups to demonstrate their capabilities. This is a critical component for institutions regarding their pension funds and other financial responsibilities.

6. Trends and Innovations

The landscape of alternative assets is constantly evolving, with new trends and innovations emerging. Importantly, much of the evolution has come due to governmental regulation--Dodd Frank, Basel III, bank capital requirements, and obligations to unload their proprietary strategies.2 As such, institutional investors are increasingly exploring sectors like renewable energy, technology startups, and cryptocurrency. Examining the breadth of opportunities with an advisor you trust is imperative when considering how or whether to figure emerging alternatives options into an institutional portfolio.

7. Regulatory and Compliance Landscape

Navigating regulatory and compliance requirements is a complex endeavor. Not all alternative funds are regulated in the same ways and so the importance of aligning with regulatory requirements in the institutional landscape is paramount. Compliance with SEC regulations, tax considerations, and reporting requirements are essential aspects of managing alternative investments effectively for institutional portfolios. This is another area where an investment advisor can prove helpful.

So, alternative assets are an intriguing opportunity for institutional investors to consider when looking to diversify their portfolios. By understanding the nuances, risks, and opportunities associated with alternative investments, institutional investors can construct resilient portfolios that strive to withstand market volatility and also aim to deliver sustainable long-term growth.

Want to discuss your institutional portfolio with a Beirne advisor? Schedule a consultation now.

_{1 "What are Alternative Investments? Definitions and Examples," by James Chen, Investopedia, October 2023}

_{2  "Dodd-Frank Act: What It Does, Major Components and Criticisms," by Adam Hays, February 2024}