11.25.2011

Alt Investments and Risk

11.25.2011
Terry Flanagan

Risks of hedge-fund and private-equity investments need to be managed carefully, an industry group says.

“Complexity and volatility are the norm for investors, as today we seem to have a 100-year financial storm about every three years or so. As a result, returns for the decades ahead are almost assuredly going to look much different,” said Steve McMenamin, executive director of The Greenwich Roundtable, a non-profit research and education group comprised largely of institutional investors overseeing a total of $2.2 trillion in assets.

“Those investors who can manage volatility and understand the complexity embedded in their portfolios will continue to be the long-term winners,” McMenamin said in a statement.

The Greenwich Roundtable recently released a whitepaper describing how investors can manage complexity of alternative investments to improve their returns. The focus of the research piece is on understanding the risks involved in hedge funds and private equity, as well as the best practices and due-diligence steps that investors can pursue to manage those risks; the risk implications of volatility, leverage, and liquidity are also explored.

A primary insight offered by the whitepaper is that the cost of alternative-investment strategies is their added complexity; the benefit is their ability to generate returns from a wide array of sources. Another conclusion is that correlations matter, and they vary over time; it is vital for investors to understand the changing nature of relationships across their portfolio.

The whitepaper also noted that investors need to understand how each manager deploys leverage and evaluate the appropriateness of the deployment. Regarding the ability to buy and sell securities easily, it was observed that liquidity is dynamic, and it changes as markets change. This calls for ongoing due diligence and manager monitoring, including stress tests.

“Each investor must decide whether [he/she] is adequately prepared to invest competently in alternative investments,” said Rusty Olson, former director of pension investments for Eastman Kodak and editor of the Greenwich whitepaper.

Neither McMenamin nor Olson were available for additional comment on Wednesday afternoon, according to a public relations representative.

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