This article was written by Everett Perry. It appeared first on the Bloomberg Terminal.
Investors have more exposure to alternative strategies than ever, but their returns are much less certain than before.
Private equity funds prospered until this year, helped by historically low interest rates. The number of private equity-backed companies in the U.S. increased to 8,000 in 2017, from 4,000 in 2006, according to a 2019 McKinsey & Co. report. Now, amid the pandemic, portfolio company exits have all but dried up, raising questions about future earnings and causing more uncertainty for investors. Hedge funds had a rougher road in the decade before the pandemic. Rock-star fund managers closed up shop, and institutions reduced allocations as steep fees became hard to justify. The Bloomberg All Hedge Fund Index returned an average of only 2.8% a year during the 10 years through Sept. 30, while the S&P 500 returned 11.5% annually on average. In recent months, though, the choppiness caused by COVID-19 has pushed allocators to increase their hedge fund holdings, especially in North America, in hopes that fund managers can take advantage of the volatility and mispricings. “Low rates, tight spreads and cheap beta had made U.S.-based investments boring for most hedge funds,” Michael Monforth, global head of capital advisory at JPMorgan, told Bloomberg News.
The problem for many investors is they still analyze their portfolios in a bifurcated way. They use sophisticated models to quantify risk and hedging ratios for stock and bond holdings, yet turn to subjective analysis and whatever delayed data managers are willing to divulge when analyzing private equity and hedge funds.
Bloomberg’s Portfolio & Risk Analytics (PORT) function assists with this problem. PORT employs more than 20 different factor models from the Bloomberg Multi-Asset Class Risk System, including ones that cover private equity and hedge funds. Bloomberg’s data-sourcing engine scrapes public records for all available data on private equity and hedge funds.
With sophisticated data cleaning and machine learning, such scraped returns and analytics can be used to formulate a reliable factor model.
With Portfolio & Risk Analytics, investors can evaluate future portfolio volatility and tracking error, simulate specific market scenarios, track value at risk, and optimize to reduce risk while abiding by constraints with private equity and hedge funds.
Use Bloomberg’s Portfolio & Risk Analytics function to quantify their portfolios’ aggregate risk, even if they hold illiquid and opaque assets such as private equity and hedge funds. To analyze a portfolio that includes private equity, run {PORT <GO>} and click on the Tracking Error/Volatility tab, then Summary subtab for a breakdown of ex-ante risk. Analyze the active total risk and compare this number with estimates for other portfolios, indexes or funds. Use the Factor Risk Contribution (%) section to see which factors are contributing most to the risk.
The outsize exposure to public equities may be an unwanted side effect for some private equity investors, especially if they already have a direct allocation to stocks. To reduce such risk, PORT Trade Simulation provides an efficient way to evaluate possible trades. For example, consider how you can use index futures to pare down equity market risk.
