(February 13, 2012) — Operations are often an aspect that is overlooked when investing in alternative assets, a newly released whitepaper by Morgan Stanley Alternative Investment Partners asserts.
The paper — published in January and titled “Navigating the Operational Complexities of Alternative Investments” — claims that as institutional investors are continually on the lookout for innovation in alternative investments, operational challenges abound. “The operational complexity of investing in alternatives can represent a practical impediment to making and managing allocations. When multiple allocations are made across strategies and managers, the burden facing investors can increase exponentially,” the whitepaper by Joseph McDonnell, Noel Langlois, and Michael Dyer of Morgan Stanley Alternative Investment Partners assert.
The paper continues: “Many sectors of the alternatives universe can be characterized by limited automation and reduced standardization of reporting, pricing, and transaction settlement. These limitations result in a dizzying degree of variety in these areas among its participants. Investing in alternative investments entails a significant operational and administrative burden for an institution’s personnel and technology infrastructure.”
Thus, the authors of the paper say that a specialized alternatives-focused operational infrastructure is imperative to handle the non-homogeneity of information.
The paper outlines six key considerations investors should consider in order to successfully structure an alternatives investment program.
1) pricing and valuation of alternative investments
2) investment decision-making infrastructure
3) document retention and archiving
4) flexible and integrated monitoring and reporting
5) segregation of investment duties
6) integration with custody relationships for alternative investments
As institutional investors increasingly seek alternative investments to boost their returns, operational complexity and increased governance burdens could become overwhelming without an appropriate infrastructure in place, the authors write. “Such challenges are not insurmountable but typically require size and scale to implement robust solutions. Often this cost threshold is too high for many investors,” the paper concludes.
While endowments have traditionally been at the forefront of pursing alternatives, another recent paper on the topic asserts that asset allocation and investing in alternatives more specifically are the main reasons for success at elite endowments.
The paper — titled “Do (Some) University Endowments Earn Alpha?” — asserts: “Elite institutions and top-performing endowments earn reliably positive alphas relative to these simple public stock/bond benchmarks of 2-4% per annum. Average allocations to alternative investments explain all of documented superior performance. When we add indexes for hedge funds and private equity to our attribution model, the estimated alphas for elite institutions and top-performing endowments move into negative territory, ranging form 0 to -1.9% (albeit generally unreliably negative). These results indicate that the average asset allocation of elite institutions and top-performing funds is the single most important determinant of their superior returns during the last 20 years. We argue the results are not consistent with manager selection or market timing (or tactical asset allocation) generating alpha for investors.”