Hedge Fund Focus

Greenwich Roundtable Releases Extensive Best Practices Report on the Role of Alternative Investments in Portfolio Construction

Following last year’s market turmoil, the Greenwich Roundtable (GR) announced today the release of a white paper on alternative investing, entitled Best Practices in Alternative Investing: Portfolio Construction. The GR Education Committee’s new study is aimed at investors who actively invest in many types of alternatives and covers private equity, real estate, venture capital, hedge funds and natural resources. It is the fourth installation in a series of Best Practices reports, following the organization’s previous reports that focused on the art and science of performing due diligence on hedge fund managers.

A valuable tool in today’s difficult and volatile investing environment, the paper provides a broad, thoughtful compilation of best alternative investing practices from veteran, institutional fund managers. In addition, the paper describes the advantages, principles, and challenges of weaving a portfolio of alternative investments into an investor’s overall fund. The importance of continually focusing on risk management and maintaining control of liquidity in constructing portfolios is firmly emphasized.

Ed Barksdale, Chairman of the Roundtable’s Education Committee, Chief Executive Officer of Stamford, CT-based Federal Street Partners and a member of Duke University’s investment committee  stated:

“This should be required reading for managers of pension funds and foundations and endowments.  Over the past few years many managers became overly dependent on mathematical models to build portfolios and manage risk. It’s time to get back to basics and this guide does just that, delivering a no-nonsense, straight forward approach to alternative investing.”

Steve McMenamin, Executive Director of the Greenwich Roundtable, added:

“This is the first overall review of qualitative approaches to include alternatives into a broad portfolio of investments.  The final result is designed to raise the professional standards, to document the process and bring about a greater awareness of best practices that had previously been passed along orally amongst the world’s most successful alternative investors.”

Aleks Weiler, the leader of the working group that created the study and Senior Portfolio Manager with the CPP Investment Board , stated:

“We began this project two years ago, after hearing concerns with leverage and overvaluations in the market.  If there’s one thing we learned last year, it is that reliance on traditional, asset allocation portfolio construction techniques, which are based on historical returns of asset classes, is not sufficient. The current economic environment must be factored in as well.”

The Greenwich Roundtable found that many institutional investors were not placing enough emphasis on economic indicators like GDP growth and inflation in constructing their portfolios.

Rusty Olson, editor of the study and former CIO of the Eastman Kodak pension fund, commented:

“The paper emphasizes the importance of diversifying an investor’s overall portfolio to provide both a degree of readiness for inflation or deflation, as well as a growing economy.”

The Roundtable’s findings related to the economic cycle included the following:

• TIPS, physical commodities, and real estate are among the better inflation hedges
•  Only two assets protect investors during deflation — cash equivalents and long-term government securities
• Public equity, directional hedge funds, and private equity flourish when the economy is growing
• High quality alternative managers with returns uncorrelated to the stock market can do well across all economic scenarios

The broad 74-page study is organized into seven chapters and focuses on the qualitative, practical measures, which should be used in building a portfolio of alternative investments. It concludes with a chapter on best practices for institutional chief investment officers and their investment committees. In addition to identifying the importance of the economic cycle in portfolio construction, the study recommends:

• Build alternative portfolios from the bottom up, limiting allocations only to what is available in top quality managers
• Avoid over reliance on mathematical asset allocation and risk models, especially those too dependent on historical data
• Ensure that the administrator and accounting firms are independent of the manager
• Maintain enough liquidity to stay the course
• Focus on what is best for your fund as opposed to what your peers are doing

About the Greenwich Roundtable:

The Greenwich Roundtable is a not-for-profit research and educational organization located in Greenwich, Connecticut, for investors who allocate capital to alternative investments. Its members collectively represent more than $6.4 trillion in assets under management. The mission of the Greenwich Roundtable is to educate sophisticated investors and to establish best practices for limited partners.