Paper Warns Institutional Investors to Overcome Operational Hurdle of Alternatives

The operational complexity of investing in alternatives can represent a practical impediment to making and managing allocations, according to a whitepaper by Morgan Stanley Alternative Investment Partners.

(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.

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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.”

Mercer: A Mere 9% of Investment Strategies Achieve High ESG Ratings

Only 9% of more than 5,000 investment strategies achieve the highest environmental, social and governance (ESG) ratings within Mercer’s Global Investment Manager Database (GIMD), and the firm sees both innovation and opportunity for improvement.

(February 13, 2012) — Less than 10% of investment strategies attain the highest environmental, social, and governance (ESG) ratings, according to an analysis performed by Mercer’s Investments business.

“The focus on ESG factors as a way of managing risk is still a relatively young concept” said Jane Ambachtsheer, Mercer’s Global Head of Responsible Investment, in a statement. “Our ESG ratings methodology gives investors an additional lens through which to view portfolio managers, particularly how longer-term risks and opportunities align with their overall strategy and how ownership rights are utilized to see that strategy through.”

According to a release by the consulting firm, strategies that achieve the highest ratings tend to share the following common features:

1) A demonstration that ESG factors feature in investment teams’ decision making processes and corporate culture

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2) An effort made to build in some ESG factors into valuation metrics, using their own judgment about materiality and time frames

3) A long-term investment horizon and low portfolio turnover

4) Ownership policies and practices that include sufficient oversight, integration with investment decision-making and transparency 

5) For alternative assets, evidence of pursuing best practices in transparency and evaluation, monitoring and improvement of ESG performance as relevant for portfolio companies and sectors

6) A demonstrated willingness to collaborate with other institutional investors to improve company, sector or market performance

7) A commitment to ESG integration at the organization-wide level

Andrew Kirton, Mercer’s Global Chief Investment Officer, added that he was not surprised to see a relatively low percentage of strategies achieve top ratings, as Mercer’s approach “involves setting a high bar”. 

He added: “There is still much work to be done by the investment community to fully integrate responsible investment practices. We would expect the number of highly rated strategies to increase over the next few years as more and more investment professionals come to recognize the sound investment and competitive reasons for active ownership.”

In June, a survey by the firm found that the vast majority of pension funds, foundations, and asset managers view climate change as both a risk and an opportunity. Overall, the survey found that 98% of pension funds and foundations and 87% of asset managers believe that global climate change poses risks but also offers opportunities. It also found that 57% of pension funds and foundations and 80% of asset managers make specific reference to climate change risk in their investment policy.

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