Portfolio Management

CHAPTER 11Alternative Investment Classes

Chapter Outline

1. 11.1 Introduction
2. 11.2 Hedge Funds
3. 11.3 Venture Capital and Private Equity
4. 11.4 Real Estate
5. 11.5 Commodities
6. 11.6 Alternatives Manager Selection
7. 11.7 Allocating Assets Including Alternatives
   1. Summary
   2. Problems
   3. Appendix: Sources for Return Series
   4. Endnotes

11.1 INTRODUCTION

Up until this chapter, the discussion has focused on managing portfolios of well-defined asset classes. Pricing data on equities, investment-grade bonds, and cash instruments in developed markets are readily available and not subject to significant pricing problems or survivorship bias. Passive investment in these asset classes is readily accomplished through separate accounts, mutual funds, or ETFs. This is not the case with alternative investment classes, which require a new approach to evaluating risk-return profiles. Note that we're careful to avoid the term alternative asset classes. As Erb and Harvey (2006) note, these investments are more like asset “strategies,” due to the general lack of effective passive alternatives or the impracticality of market capitalization–weighting schemes.

If alternatives offer an opportunity to expand the efficient investment set, then merely investing in the familiar assets—stocks, bonds, and cash—will be suboptimal. Commodities, real estate, and new business ventures are all considered alternative investments. Hedge funds, which frequently invest in publicly traded stocks and bonds, are also considered alternative ...