PE Funds Using Alternatives for 8% Returns are Living in a Pipe Dream

PE Funds Using Alternatives for 8% Returns are Living in a Pipe Dream

PE Funds Using Alternatives for 8% Returns are Living in a Pipe Dream

The Blackstone Group L.P (NYSE:BX) CEO and chairman, Tony James, is of the opinion that pensions stand to remain insolvent if they keep investing in hedge funds, and advises that they should start thinking of alternative investment vehicles. He points out that the pensions can only yield 7% from investment in hedge funds, something that he feels is not good enough to drive pensions towards the solvency zone.

However, the big question is based on the methodologies and factors, which the The Blackstone Group L.P (NYSE:BX) chief took into consideration when coming up with his assessment. Technically, it does not sound mathematically possible, considering that hedge funds, along with private equity, derive their returns from overall market performance. Actually, hedge funds and private equity are likely to do far better than index funds. They return what the market gives, less the high fees.

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James is quoted saying, “If the nation is going to be able to provide for its future, pension funds and other institutional investors must earn more than they can get in public markets.” He then adds, “they must do so on a scale large enough to move the return materially on hundreds of billions of dollars. James then points to the alternative instruments as the only option saying, “I believe that only alternative investments can fill this need.”  “Indeed, I don’t think the US pension system can come close to being solvent without having major investments in alternative assets”, he concludes.

James claims that the 2% offered by investment grade rated vehicles, like government bonds, are not the way to go, he adds that the pensions need to earn a return of at least 7.5% to 8% across their portfolios in order to finance their obligations fully.

With regard to hedge funds and private equity, James points out that due to the declining economic growth rate, he believes its currently negative as a major adverse effect on the instruments. He connotes that the artificially inflated economic growth experienced over the last forty years is one reason public instruments have been doing well in terms of return.

Therefore, he believes the stock markets will return nothing more than 5% to 6%. James adds, “so, if a fund has most of its money in bonds and stocks, with returns  ranging between 2% and 6%, and it has to get to 8% to be solvent, the only way it can do that is to put a sizable chunk of its portfolio in alternatives that can earn double digit returns. “

However, according to 2011 hedge fund returns results, a majority of the top firms returned more than 20% in value. In fact, the top hedge fund for the year, Tiger global management, returned a whopping 45%. Additionally, hedge funds and private equity are what forms the market, Tiger’s portfolio includes investment in stock market equities, as exhibited in its latest sell-outs in Facebook Inc. (NASDAQ:FB), just before the massive fall, and Linkedin Corporation (NYSE:LNKD), where it earned over 400% return on original investment.

Furthermore, James’ recommendation of alternative instruments, such as futures markets, stock indexes, and commodities, do not give any guarantee that the return will be higher. There is risk involved in every alternative, apart from the government issued securities.


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