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Six Disruptions in the Investment Industry and the Future of Alpha

Date:
Mar 13, 2017

While investing has never been straightforward, investing today in the face of current uncertainty may seem overwhelming.

Traditional approaches to constructing a portfolio — those that investors have relied on for decades — appear outdated.  From today’s vantage point, one might say that the “arc of alpha” suggests the following:

  1. Given today’s starting valuations and current yields, many investors have little confidence that the same equity/bond portfolio that has generated meaningful returns over the past 30 years  will be able to produce the investment returns expected and likely needed by a family to maintain wealth for generations.
     
  2. Many sophisticated investors have moved away from the perceived precision of the mean-variance optimized asset allocation approach and acknowledge its many limitations. An entire investment advisory/consulting industry has, in the past, suggested that setting the asset allocation at the asset class: “x percent in international equities, and y percent in emerging market bonds”, will generate not just a reasonable portfolio, but actually the optimal portfolio, for which no other combination of assets can be expected to provide a higher risk-adjusted return. 
     
  3. Current flows into indexed investments — around the world — suggest that many investors are rethinking their reliance on active managers to generate potential returns. Coupled with getting the asset allocation “right”, many investors have relied upon active long-only managers to produce “alpha” both by picking the right securities and by managing risk by avoiding potential losers or getting out of the market at the right time.
     
  4. Hedge funds have generally delivered on the promise of volatility reduction, but have been less successful in delivering strong fee-adjusted returns, particularly since 2008/2009. Many investors sought alpha by investing with smart, nimble managers, as they hoped that the generous fee arrangements would incent exceptional investors to produce strong risk-adjusted returns.  Many have been disappointed.
     
  5. As more money has flowed into private equity through funds, some investors believe private equity is getting crowded. Following the Global Financial Crisis, interest increased in private equity funds, with investors hoping to generate both an illiquidity premium and strong returns, sourced from the general partner’s ability to find good companies, improve their management, and move them to attractive exits. Given today’s flows, can private equity funds continue to deliver?
     
  6. We have seen a significant increase in interest among families and family offices for investing directly in real estate or operating businesses. Given the observations above, many investors are moving away from relying on traditional investments in marketable securities or hedge and private equity funds to provide strong returns.  Instead, investors’ appetite has increased to buy operating businesses or direct real estate with the expectation that these businesses may generate double digit return. (FOX members expect their direct investments on average to generate a 14% return (source: FOX Global Investment Survey, 2016.)  In addition to the potential for higher returns, many investors prefer to have more connection to their investments - a building that they can touch, tenants that they can speak with, or a business that has a product and employees.  Often, families may also want to encourage entrepreneurialism across the next generation by having the chance to participate in a private operating business.

Investing today is enormously challenging. A membership organization committed to connecting investors of private capital with one another, and providing educational resources, is more important than ever. Family Office Exchange takes pride in providing an active network serving more than 370 family office members around the US — and the world.

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For more, learn about the FOX Spring Global Investment Forum™ — bringing together the most sophisticated investors of private capital across the FOX community to address the pivotal investment issues of today.