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Arun Muralidhar (Photo credit: Princeton Headshots)
Sometimes that’s a good thing, but more often than not, it’s because memory is scarce in asset management. As Mark Twain said, “A clear conscience is a sure sign of a bad memory.” The increasing allocation to private assets in institutional investor portfolios around the world is usually a cause for concern. Although not the reason, investors seem to have forgotten and are somewhat oblivious to the damage these allocations did to Ivy League (or “Yale Model”) portfolios in 2008. These investments involve beta risk.
To evoke the memories of those who lived through 2008, and to share that history with those who didn’t, as the stock market slumps, high allocations to personal wealth are becoming more common, with little or no risk management associated with that allocation. What was done without being done at all created major cash flow problems. In 2008, the global financial crisis caused many asset owners to sell off, be forced to borrow in the capital markets, sell physical stocks without realizing they were leveraged and went long. I did some incredibly stupid things like putting it into futures to secure margin (this actually happened with a large endowment). It led to poverty, with professors being fired, student aid cut, departmental budgets slashed, and capital spending cut. In the pension world, this has led to a decline in funding status and an increase in contributions at the worst possible time.
Why do institutional investors flock to personal assets? A generous argument is that they get higher returns and diversification benefits. A more rigorous argument, most emphasized by Oxford University’s Ludovic Farippou and Nobel laureate Myron Scholes, is that on a risk- and fee-adjusted basis, investors do better by investing in the Russell 2000 Index. This means that it is possible to obtain liquidity.
The correlation argument is false. Private assets are marked into the market at the discretion of the asset manager (ignoring governance issues that arise when a manager marks an asset), so investors can see the correlation between this income stream and public assets. cannot be calculated. Protect your assets without intentionally deceiving.
A more reasonable argument is that the rarity of marks helps protect portfolio valuations from excessive volatility. This is simple and straightforward. Interestingly, Christina Chen Oster, founder and CEO of her M2M Capital, a valuation provider, offers her clients a great way to frequently get marks for these assets (completely Disclosure: I am an advisor to her company). But I’m worried that she won’t succeed. Because, from CIOs to regulators, probably no one wants this transparency and frequent marking of assets. Rumors have it that secondary trades in high-quality private assets are taking place at 30% below list price, especially if the portfolio includes duds (like dead unicorns). does not bode well for obtaining a true market valuation. )!
If CIOs believe we are not on the brink of a new crisis, they are choosing to ignore the data: rising trilateral geopolitical risks, rising inflation, A fairly sustained economic slowdown, bloated central bank balance sheets, a collapsing commercial real estate market and large illiquid allocations limit liquidity provision during a crisis. A recent lunch with four very smart CIOs confirmed this concern.
But as I wrote for CIOs in June 2012, “Risk measurement is not risk management.” The biggest risk in these private assets remains the beta, perhaps 90% given the leverage of these assets. There is no doubt that private asset managers do not manage this risk. They are in the beta phase of the asset because they are in the alpha-oriented business of finding private companies, rehabilitating them, and selling them for a profit. trade. The responsibility for managing private asset beta therefore lies with the pension funds and endowments that invest in it, and not doing so is, in my humble opinion, terrible governance. In speaking with representatives of pension funds and endowments in Canada, the Netherlands, Switzerland, and the United States, I have found that large amounts of equity in portfolios (worth billions of dollars) are left unmanaged. We are deeply concerned about the systemic risks caused by this.
What should innovative funds do? Don’t increase leverage, as some funds have done. A fund must have a process in place to map personal asset exposures to liquidity futures contracts before initiating such investments. Current software provides risk measurement parameters such as value at risk and exposure to strange factors such as growth and inflation. Risk management is about dynamically tilting the portfolio, so investors want to focus on beta exposures/futures that are likely to go up and sell/hedge these exposures if they are likely to go down. Masu. Strategic asset allocation is not a static asset allocation. Markets are dynamic, so leaving your portfolio empty is also a tactical idea. This means that the beta exposure implied by the external administrator’s decisions is appropriate.
The most efficient way to do this involves using liquid futures where data is freely available, removing investors’ dependence on third-party risk measurement providers. San Diego County introduced this approach in 2008, but Ivies struggled for a while because it shorted the Russell 2000, thereby extracting beta at bad times and liquidating illiquid assets. It’s that simple. CIOs can do the same for private credit and other illiquid assets.
Naive investors will argue that this is market timing, tactical, and an impossible process to implement. All investments are based on market timing and tactics. It is a tactical decision to assume that personal wealth will give him a 9% annual return over 10 years, and market timing to do nothing for the next 10 years to manage the beta. Additionally, most assets lose money at least 45% to 47% of the time, so to do well, especially in bear markets, investors need to be right 55% to 58% of the time, but with sufficient reward. It’s not a difficult bogey for investors who are gaining. We trained CIOs to overcome it.
CIOs like San Bernardino County’s Don Pierce have added more than $1 billion by intelligently rebalancing robust internal models (and implemented using futures), and with the right effort, intent, and With governance, these results demonstrate that returns and risk management can be improved. .
To not do something along these lines is to succumb to another of Mark Twain’s warnings: “There are two times in a man’s life when he should not speculate: when he cannot afford it, and when he can.”
Dr. Arun Muralidhar is the co-founder of Mcube Investment Technologies LLC (www.mcubeit.com) and AlphaEngine Global Investment Solutions LLC (AEGIS).
This feature provides general information only, does not constitute legal or tax advice, and may not be used as a substitute for or for legal or tax advice. you can’t. The opinions of the authors do not necessarily reflect the position of ISS Stoxx or its affiliates.
Tags: alternative investments, Arun Muralidhar, wealth management, Donald Pierce, personal wealth, private markets
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