Portfolio Design: A Modern Approach to Asset Allocation

Chapter 13

Asset Allocation with Alternative Investments

Alternative investments have captured the fancy of investors, both individuals and institutions. Many of these investors have become convinced that the bull market in equities experienced in the 1980s and 1990s is over, and that the secular downturn in inflation that led to unusually high bond returns is also drawing to a close. Many of those same investors have heard of the incredible returns earned by institutional investors like Yale University who have shifted from conventional stock and bond investments to alternative investments like real estate, hedge funds, and private equity. In Chapters 9 to 12, we have examined the chief alternative investments one by one. These investments have many attractive features as well as some important drawbacks. Now it is time to consider how well they perform in a portfolio. The first section of the chapter considers what we might term alternative investments for the ordinary investor as recommended by a leading institutional investor. The second section then introduces what we might term more exotic alternative investments, namely hedge funds, commodity futures, and private equity. The investments are evaluated in portfolios designed for high net worth and ultra-high net worth investors, respectively. The third section then examines the extraordinary record of one institutional investor, the Yale University Endowment, over the period since 1985 when David Swensen took over its direction. ...