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Change is in the air: ALTS-SV 2018 conference
Silicon Valley was the setting for ALTSSV 2018, an annual event of leading experts across the alternative investment spectrum.
October 10, 2018
A blog post by Doug Dannemiller, investment management research leader, Deloitte Services LP
The conference brought together private equity (PE), venture capital, and hedge fund managers with their pension fund clientele. The investment managers spoke about managing change in their firms, while a few large institutional investors discussed their approaches to managing return and liquidity goals in their portfolios.
The challenges shared by the two groups are significant. In summary, they seek to:
- Maintain sufficient liquidity
- Generate target investment returns (approximately 7 percent)
- Meet current retiree payment obligations
- Manage risk
One complicating factor for large pension investors is that they are facing changing ratios of employees to retirees. As retirees outnumber employees, liquidity and volatility in the investment portfolio become practical problems that impact daily operation as opposed to theoretical problems about future asset liability balances.
Balancing additional risk with risk-adjusted returns
The very nature of investment risk came under question in discussions I heard at this conference. Allow me to clarify: After several years of top decile returns, one pension manager reviewed its returns on a risk-adjusted basis and found that–through this lens–the returns were below average. That meant that while the portfolio was rewarded for taking on additional risk, the amount of reward was insufficient for the added risk taken. Based on this analysis, the pension manager decided to reallocate its portfolio by decreasing the active equity allocation while increasing the passive equity, absolute return, and real asset allocations. The goal of these changes was to reduce the risk in the portfolio and improve the risk-adjusted return.
If the historical returns had been higher on a risk-adjusted basis, presumably these changes would not have been made. What makes this a real conundrum for pension plans and investment managers alike is that retirees are paid out with actual investment returns. Whether or not the portfolio took on extra risk to achieve a better result is irrelevant to the retiree. I wonder what the pension manager's changes would be if it had experienced bottom decile performance, but with favorable returns on a risk-adjusted basis. Would it have decided to boost its active equity allocation? Would they have selected new active managers?
Pension investments in private equity: Direct or through fund offerings?
Another change reported by a large pension manager was an increase in private equity direct investment, rather than through PE fund offerings. The pension fund representative noted one rationale for moving in this direction was its desire to increase the holding period beyond that of the PE fund itself. This approach has some underlying risks that are difficult to quantify. When a PE fund seeks co-investors, those deals are typically larger than usual. How does the PE firm's track record and expertise apply to these larger-than-usual deals? It is unlikely that the risk and return profiles are identical between co-investing and investing in the PE fund. How would an institutional investor figure out the differences, if that is even possible?
Alternatives managers are faced with keeping these investors happy, while maintaining a competitive edge over their peers as they vie for assets under management (AUM). One approach mentioned by a hedge fund manager was to increase throughput and rigor of investment analytics through technology. It was estimated that a human analyst with minimal advanced technology augmentation could follow about 100 data elements on 50 securities. With advanced analytics in place and operating 24/7, that same analyst could cover many times that volume of information. With increased coverage, the analysts will review more investment opportunities. For PE firms there is a value-creation factor of success in addition to the initial investment decision. Given the younger nature of some private firms and the seven-year investment horizons, this factor along with technology-enabled selection criteria can have an important impact on results. Deep industry knowledge and processes to drive shared learning across portfolio companies are differentiators for PE firms.
Alternatives and alternative data
The highlight of the conference for me was guiding roundtable discussions on alternative data. In these discussions, the questions and topics were wide ranging:
- What is alternative data?
- Are there unique risks to using it?
- How do I get started?
- What are the factors that contribute to success?
With all these great questions floating around, the roundtable had a spirited discussion addressing them. I think it is safe to conclude that there is certainly disequilibrium of knowledge about alternative data, but the alternative investment community is eager to learn more.
What is a conference without a visionary self-made billionaire sharing his (provocative) thoughts? His first piece of advice was to be flexible rather than dogmatic. To determine where you are on that spectrum now, this leader suggests that you ask yourself if you would rather be successful or right. People willing to sacrifice being right for success are, in his view, more able to have an open mind, allowing them to find the right path. His other striking idea or prediction was that, given the pace of change in the world today, 50 percent of the equities in the S&P 500 index will be "gone" in 15 years, representing a sharp rise in turnover in the index compared to the previous 15 years. This view, if it holds true, means the sell discipline for active managers may be an important source of alpha, as much as finding the unicorns that replace the dinosaurs currently in the index.
Alternative data investing
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What are your thoughts on alternative investments?
As a group, will they be able to keep pace with investor demands, changing markets, and changing technologies? Will some firms fall to the wayside?
Join the conversation on Twitter: @DeloitteFinSvcs.
QuickLook is a weekly blog from the Deloitte Center for Financial Services about technology, innovation, growth, regulation, and other challenges facing the industry. The views expressed in this blog are those of the blogger and not official statements by Deloitte or any of its affiliates or member firms.