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Alternative Investments

Wells Fargo Investment Institute - May 2017

Head of Global Alternative Investments Adam Taback discusses how alternative investments have the potential to provide attractive risk-adjusted returns in the year ahead.

Transcript: Alternative Investments

Over the last few years, we have seen a macroeconomic environment driven by key themes including strong domestic equity performance, persisting low interest rates, low volatility, and low inflation. For example, large-cap equities, as measured by the S&P 500 Index, are up 249 percent since March 2009 (as of the end of March 2017).

However, we believe we are entering an environment where many of these themes are changing. Our outlook for global equities is tempered significantly for 2017, and into 2018, with low-mid single digit projections for most equity categories. We expect a modest pace of economic growth to continue in the U.S.; however, we remain aware of the risks and market swings, and expect episodic volatility, that may be exacerbated by macroeconomic and geopolitical uncertainty.

We believe this environment creates an opportunity for active management in general—particularly for alternative investment managers that have the most flexibility to take advantage of these changes, such as hedge funds and private capital strategies.

For investors who own a diversified portfolio, it has been difficult to generate relative returns, that is, returns relative to a benchmark index. The S&P 500 Index has had a great run and owning a portfolio of diversified assets, versus only large cap equities, appears to have taken away from returns.

In our opinion, now is not the time to consider passive investment options only, but to allocate to active management as well. It is our belief that the next five years is likely to look a lot different than the past five years. History has taught us that it’s extremely difficult to predict the top performing asset class year over year, which is why we believe a balanced portfolio that includes alternative investments, such as hedge funds and private equity, is extremely well positioned in the current environment as we look forward to the year ahead.

In fact, when compared to all of the other major asset classes (stocks, bonds, real assets) in our recommended portfolios, Wells Fargo Investment Institute is forecasting alternative investments to have the potential to provide attractive risk-adjusted returns in the year ahead. We think this makes the need for the diversification benefits of a four asset class model that includes alternative investments critical to helping investors achieve their long-term investment goals.

Alternative investments tend to react to economic events in ways that are different from traditional stocks and bond investments, so adding them to a diversified portfolio may provide a number of potential benefits. These benefits include a greater potential for diversification, exposure to a broader range of investment opportunities, and the potential to provide attractive risk-adjusted returns.

To reap the benefits of alternative investments, our recommended allocations range from 13-24 percent, depending on a qualified investor’s risk and return objectives.

In the current market, we strongly favor certain areas of private capital, as we feel the ‘illiquidity premium’ that comes with these investments is very real and can benefit many investors by offering return opportunities that are not available elsewhere in a portfolio.

We also have high conviction in hedge funds, as we view their role in a portfolio as participating in up markets—albeit to a lesser extent than pure equity exposure—but perhaps more importantly, limiting downside exposure. In the current environment, we favor hedge fund dispersion strategies such as Equity Hedge and Relative Value.

As we look forward, we believe many investors are under allocated in alternative investments. We encourage investors to right-size back into the recommended strategic allocations.