Go Big or Go Home: The Case foran Evolution in Risk Taking

Abstract

This article argues that alternative investments—private equity, real estate, and hedge funds—have natural advantages in risk and return over traditional stock and bond investments. A large allocation to alternatives relative to current institutional practice is needed for a material contribution to an institutional investor’s bottom line. Investors should consider whether moving toward an “efficiency” portfolio with an emphasis on low-cost passive management or an “opportunity” portfolio with heavy reliance on value added through active management—especially alternative investments—is most appropriate for them. Investors who can tolerate the cost, complexity, and illiquidity should consider opportunity-type allocations of 40% of their return-seeking assets to private equity, non-core real estate, and hedge funds. Over time, institutional investors will likely choose alternative investments and indexing as their primary investment options, and traditional active management will likely transform to take on qualities currently associated with alternative investments.