Tracy Gallagher is the Head of Alternative Investments at Arta Finance in Mountain View, Calif., where she oversees strategy and manager selection. Prior to Arta, she was with LGT Capital Partners in New York, investing in Private Equity and Venture Capital funds.
Jeff Benjamin: Why are alternative investments important in the current market environment?
Tracy Gallagher: Well, we’re already in a volatile market environment with unrest in the Middle East and Europe, coupled with interest rate volatility domestically, and headed into a major election year in the U.S.
A meaningful allocation to alternatives can help a portfolio weather public market uncertainty given the long-term orientation of alts.
JB: How can advisors get started researching alternatives?
TG: In order to start including alternative investments in portfolios, one should first understand the mechanics, benefits and risks of each asset class.
Private equity plays a very different role as a growth driver versus real estate, which can act as a hedge against inflation versus private credit, which can be a meaningful income generator.
One resource I always recommend is Pioneering Portfolio Management by David Swenson, who established the endowment framework at Yale University. I particularly recommend the chapter on Alternative Asset Classes.
JB: How much alternative investment exposure should investors have in their portfolios?
TG: That depends on your liquidity needs. Most alternative investments or private funds lock up the capital for some period of time.
These liquidity periods can vary dramatically from quarterly to 10-plus years. So, you shouldn’t lock up capital that you may need for a home renovation, college, etc.
Most models recommend somewhere between 20% and 30% exposure to alternative investments.
JB: What are some alternative strategies worth considering?
TG: Alternative investments, also referred to as private assets, include strategies like venture capital, private equity, hedge funds, private credit and real estate.
JB: How do you respond to criticism about the higher fees and lower liquidity associated with alternative investments?
TG: It’s a fair question. Investors and financial advisors should be assessing returns net of fees, meaning what are the returns after subtracting any management fees and performance fees.
Using private equity as an example, the asset class net of fees has outperformed global equities by over 350 basis point on a five-, 10- and 20-year time horizon.
Sticking with PE to answer the liquidity question. On average, private equity investments are held three to five years. This enables fund managers to work closely with management teams to grow revenue, bolster margins, expand into new products and geographies, and a number of other initiatives.
The locked-up nature enables private equity firms to maximize long term returns versus being laser focused on the quarterly share price impact like a public company might be. Also, without liquidity constraints, private fund managers might be forced to sell assets at inopportune moments which would likely eat away at the outperformance these strategies have been able to deliver over long time horizons.