Alternative Investing: Cure for Stock and Bond Blues?

Market Context & Expectations

• The S&P 500 averaged a 6.9% annual return over the previous decade; the Barclays Aggregate Bond Index averaged 5%.
• Conventional wisdom suggests traditional equities and bonds will underperform over the next 5–10 years, driving demand for alternative investments.
• Panelists cite high correlations between risky assets (stocks, bonds, commodities) during crises (2001–2003, 2008) as a reason to shift from asset-class-based to risk-based allocation strategies.

Real Estate & Real Assets

• Scott Sperling (Thomas Lee Partners):
  • Highlights real estate credit as "extremely compelling" due to the retreat of banks, offering mid-teen returns with short duration and lower interest rate exposure.
  • Identifies light industrial assets as a key growth driver, fueled by the "Amazon Prime" phenomenon necessitating expanded distribution centers.
  • Notes single-family rentals as an attractively valued, emerging asset class.
  • Warns that REIT indices now hold a significant portion of the sub-$1 trillion U.S. REIT market; an upcoming industry code change will likely increase index ownership, reducing diversification opportunities for investors.
• Kerry Tomei (Wisconsin Alumni Research Foundation):
  • Adopted a risk-parity "All-Weather" strategy starting in 2004, aiming to match returns with lower risk or increase returns with managed volatility.
  • Currently leverages bonds via futures to overlay hedge fund strategies, maintaining a market-neutral focus for alternative allocations.
  • Achieved a 10-year performance ranking in the second percentile of peers while reducing portfolio volatility.
• Jody Gunsberg (S&P Dow Jones Indices):
  • Observes equities have outperformed commodities for eight consecutive years, the longest streak since 1970.
  • Recommends mixing the capital structure of real assets (equities, fixed income, futures) to lower volatility from 17.5% to roughly 10% while retaining inflation protection.
  • Identifies a weak U.S. dollar and specific commodity shortages (only 1 of 24 commodities is currently in short supply) as key market drivers.

Private Equity & Buyouts

• Scott Sperling:
  • North American buyouts have delivered ~13–14% compound annual returns over 20 years, outperforming the S&P's ~7% due to disciplined timing and active management.
  • Strategic buyers are increasingly dominant, utilizing low interest rates (1.5%–3%) to pursue acquisitions for EPS accretion, forcing PE firms to focus on operational improvements to justify higher multiples.
  • Woodcreek has been a net seller of assets over the last three years, favoring "off the beaten path" smaller deals to avoid auction competition and enter at lower multiples.
  • Predicts that proprietary deal flow and enhanced operating expertise will sustain 500–600 basis points of outperformance despite a harder market environment.

Commodities & Inflation

• Jody Gunsberg:
  • Views the current commodity rally as potentially a "bear market rally" due to lack of broad fundamental support and high U.S. oil inventories limiting OPEC's pricing power.
  • Notes that agriculture and livestock offer short-term return opportunities driven by weather volatility (e.g., El Niño) destroying supply.
  • Highlights energy's high "inflation beta" (15x for production-weighted indices) as a primary tool for inflation protection, despite poor recent returns.
  • Identifies the Chinese stock market volatility in Q1 of the current year as a catalyst that spiked correlations across all risky assets, challenging risk-parity models.

Intellectual Property (IP)

• John Rotolo (Woodcreek):
  • Allocates 30–40% of the portfolio to IP assets (music catalogs, film rights, pharmaceutical patents) viewed as core infrastructure in a knowledge economy.
  • Utilizes the varying legal lives and cash flow timing of different IP assets to "ladder" portfolios, creating diversified risk-adjusted returns.
• Kerry Tomei:
  • Has evaluated IP investments but currently finds no need to diversify away from their existing portfolio focus.

Fees, Liquidity, and Disclosure

• Kerry Tomei:
  • Targets a net 200 basis point alpha overlay; notes that fees are acceptable if true alpha is generated.
  • Successfully negotiated a 0% management fee with a hedge fund manager in exchange for a 30% incentive fee on an 8% hurdle rate.
• Scott Sperling:
  • Argues that liquidity premiums are often mispriced in supposedly liquid asset classes (like ETFs) compared to illiquid assets where liquidity can be accessed quickly in small blocks.
• John Rotolo:
  • Emphasizes that institutional investors use illiquidity as a competitive advantage to capture returns over 10–25 year horizons.
  • Prefers cash-flowing assets that provide periodic liquidity windows to reduce "vintage risk."
• Jonathan Grunzweig (Colony Capital):
  • Warns against embedding fundamentally illiquid assets into daily-marked public vehicles (e.g., non-traded REITs, listed REITs with illiquid cores), citing potential transparency and redemption mismatches.

Retail & Distribution Trends

• Morningstar reported 157 alternative asset mutual funds with $55 billion in assets as of the time of the panel, a significant increase from 25 funds and $6 billion in 2007.
• Panelists agree that defined contribution systems (401ks) currently fail to provide adequate diversification for retail investors.
• Jonathan Grunzweig notes that packaging illiquid assets for daily retail liquidity creates significant structural risks, similar to the high-yield bond ETF liquidity mismatch.
• John Rotolo suggests that some alternative assets (e.g., music royalties) are conceptually easier for retail investors to understand than complex long-short hedge fund strategies.
• Scott Sperling cautions that retail products often rely on conventional wisdom regarding correlations that may fail during crises, posing a risk to uninformed investors.

Forward-Looking Statements

• Scott Sperling: Believes the ability to generate outperformance in private equity will persist if firms can execute operational improvements and secure proprietary deal flow.
• Jody Gunsberg: Suggests a potential switch to commodities is viable if historical cycles repeat, but warns that current market dynamics (correlations, supply gluts) may differ from the 1980–1990 era.
• Scott Sperling: Predicts that rising interest rates driven by inflation will generally support real estate values, though cap rate expansion could cause temporary value diminution.
• Jonathan Grunzweig: Anticipates a "generational change" is required to better accommodate alternatives within the 401(k) space to match the massive scale of institutional capital allocation.