Alternatives can widen the opportunity set, but they should be judged by portfolio function rather than novelty. The key questions are risk, liquidity, transparency, governance and fit.
Define the portfolio function
An alternative can serve growth, income, diversification, inflation sensitivity or access to an unlisted opportunity set. If the function is unclear, the allocation is difficult to govern.
Evaluate transparency and control
The less liquid or familiar the strategy, the more important reporting, valuation policy, custody, governance and manager accountability become.
Separate diversification from complexity
Complexity does not automatically create diversification. The relevant question is how the strategy behaves relative to the rest of the portfolio, particularly in stress.
Size alternatives around liquidity
The combined allocation to private and illiquid assets should reflect expected cash needs, commitments and the investor's ability to tolerate long holding periods.
A short decision checklist.
- What job is this capital expected to perform?
- What are the principal sources of return and loss?
- How much liquidity could be needed under stress?
- What assumptions would invalidate the decision?
- What review rule will govern the allocation after the initial decision?