The Demise of Alternative Investments

Alternative investments, or alts, cost too much to be a fixture of institutional investing. A diverse portfolio of alts costs at least 3% to 4% of asset value, annually. Institutional expense ratios are 1% to 3% of asset value, depending on the extent of their alts allocation. Alts bring extraordinary costs but ordinary returns—namely, those of the underlying equity and fixed income assets. Alts have had a significantly adverse impact on the performance of institutional investors since the Global Financial Crisis of 2008. Private market real estate and hedge funds have been standout underperformers. Agency problems and weak governance have helped sustain alts-investing. Chief investment officers and consultant-advisors, who develop and implement investment strategy, have an incentive to favor complex investment programs. They also design the benchmarks used to evaluate performance. Compounding the incentive problem, trustees often pay bonuses based on performance relative to these benchmarks. This is an obvious governance failure. The undoing of the alts-heavy style of investing will not happen overnight. Institutional investors will gravitate to low-cost portfolios of stocks and bonds over 10 to 20 years.