The Education Committee of The GreenwichKnowledge,R Veracity,oundtable Fellowship 2009 In This Issue Building a Successful Portfolio of Alternatives Best Practices In The Two Principles Alternative Investing: PORTFOLIO CONSTRUCTION Putting It All Together: The Old School & The New School Good Governance: The Crucial Element Research About the Greenwich Education Council Roundtable Committee Anonymous The Greenwich Roundtable, Inc. is a not-for BEST PRACTICE MEMBERS BlackRock, Inc. profit research and educational organization located in Greenwich, Connecticut, for Edgar W. Barksdale Blenheim Capital Management investors who allocate capital to alternative Federal Street Partners investments. It is operated in the spirit of an Chairman Bridgewater Associates, Inc. intellectual cooperative for the alternative Nathan Fischer Graham Capital Management investment community. Mostly, its 200 members are institutional and private investors, who Lumina Foundation for Education Lumina Foundation collectively control $6.9 trillion in assets. Ray Gustin IV Drake Capital Advisors, LLC Kingdon Capital Management The purpose of the Greenwich Roundtable is Robert Hunkeler Marlu Foundation to discuss and provide current, cutting-edge information on non-traditional investing. Our International Paper Company Newman’s Own Foundation mission is to reveal the essence of both trusted Lyn Hutton and new investing styles and to create a code Commonfund Group Paulson & Co., Inc. of best practices for the alternative investment industry. Price Waterhouse Coopers Russell L. Olson Formerly Eastman Kodak pension fund Alexis Palmer Memorial Sloan-Kettering Cancer Center The Research Council enables the Alexander Poletsky Greenwich Roundtable to host the Greenwich Roundtable, Inc. broadest range of investigation that serves the interests of the limited Editor partners and investors. This group Mark Silverstein wishes to help investors document the allocation process. Their business Endurance Specialty Holdings Ltd. activities serve as an example to all of their sincere desire to educate Aleksander F. Weiler investors and of their belief in our CPP Investment Board mission. Members of the Research Leader, Best Practices Subcommittee Council not only provide no-strings funding but they have also assisted the members of our Education The Education Committee has been working as a Committee by rolling up their sleeves group of altruistic investors who contributed their time in the discovery and editing phases. and worked to raise professional standards. The final result is intended to demystify alternative investing and to bring about greater understanding. Investing in alternatives is not well documented. The Education Committee is chartered to conduct original research and develop best practices from the investors’ point of view. © Greenwich Roundtable 2009 2009 G BEST PRACTICES IN ALTERNATIVE INVESTING: 2 R G Acknowledgements R Investor education is “ one of the greatest needs in I am grateful for—indeed humbled by—the On her weekend retreats in New Hampshire, depth of commitment of so many friends, Lyn Hutton edited several drafts and provided the marketplace. investors, and members. This was truly a team many innovative insights. Lyn often provided a ” operating at its best. It would be difficult not middle way to reconcile the philosophical dif- —Stephen McMenamin to acknowledge first, Aleks Weiler, the leader ferences between the quantitative and qualita- Executive Director of our Best Practices Working Group. Aleks tive approaches. Bob Hunkeler, also a trustee of went headlong into this project with a calm the Roundtable, kept us focused on the realities determination and a pursuit of excellence. He of the investment trustee’s experience. It was his conducted all of the original focus groups that idea to write with an eye on educating trustees cut across investor types and asset classes and who incur the liability and provide governance. wrote the first draft. Ed Barksdale, a GR trustee Finally, Nathan Fischer opened our minds to and Chairman of the Education Committee, set organizing the portfolio along functional rather the tone for the discussion when he suggested than asset class lines. that we emphasize the qualitative aspects of portfolio construction. For more than two We are deeply grateful to the members of the years he generously opened the doors of his original focus group. Peter Bernstein challenged offices for this diverse committee to meet. To us to show how to “play by ear.” Charley Ellis say that Rusty Olson was invaluable would be urged us not to look at our neighbor’s work. an understatement. His clear thinking and his Clark Binkley unlocked the world of timber, clean writing style transformed this work into and John Hill guided our view on energy. Rian a readable, enjoyable summary. His unselfish Dartnell painted the picture from the private respect for other opinions served to inspire oth- investor’s view. Peter Lawrence, Sue Carter, ers to do the same. Meanwhile, GR staff editor, and Alexis Palmer took us on an insider’s Alex Poletsky, was Rusty’s mission control. tour of the venture and private capital mar- This former newspaperman tirelessly rewrote kets. Barry Sternlicht gave us a foundation to and negotiated over 20 drafts. Mark Silverstein build our view of real estate. Neal Triplett and provided most of our guidance on managing Mary Cahill offered the endowment perspec- risk. His practical common sense approach tive. We also appreciate the editorial insights was only exceeded by his humility and good- of Ray Dalio, Mark Casella, Don Raymond, natured cooperativeness. Ray Gustin provided Afroz Qadeer, John-Louis Lelogois, and Wim a lot of our intelligence on hedge funds. His Kooyker. ability to articulate the nuance was invaluable. PORTFOLIO CONSTRUCTION G 2009 R 3 Introduction “ By three methods we may learn wisdom. First, each alternative investment grouping: hedge by reflection, which is noblest; second, by imi- funds, private capital, real estate, and natural tation, which is easiest; and third, by experi- resources. In each case we discuss the various ence, which is bitterest.” sub-styles of each grouping, issues around fund- —Confucius ing, and idiosyncrasies particular to each. Greenwich Roundtable members practice a The final chapter on governance expands on different investing approach with an active some practical elements to bringing about a management style in alternative investments solid fiduciary structure. In all, we stress that such as hedge funds, private equity, real estate, we should strive to do what is right for our and commodities. We have written on the art institution and not what others are doing. and science of finding, evaluating, and hiring talented managers (the three Best Practices in Conversations on all of these topics began two Hedge Fund Due Diligence white papers). years ago and took on greater importance early in 2008 when our symposia speakers’ darker We now turn our attention to building and prognostications became reality. We sat down managing a portfolio of alternative investments. early in the summer of 2008 to begin the work of speaking to the members and friends of the We entered the project with the simple notion Greenwich Roundtable in the same spirit we that there is no one right way to craft a portfo- approached our other research: openness and lio. We manage portfolios based on the needs curiosity coupled with humility as we faced the of our institutions, not by market conventions. scope of the topic. Also, we determine our own appropriate risk levels. Most importantly, as the Roman phi- Throughout this paper you’ll see frequent uses losopher Seneca said almost 2,000 years ago, of “we” and “our.” These refer to investors “When a man does not know what harbor he is who are responsible for managing a portfolio making for, no wind is the right wind.” for an institution or themselves. It is for them that this study has been written. Chapter 1 distills the philosophical framework behind best practices in portfolio construction Overall, we hope that you find this publication into two basic principles: Collect quality part- helpful in navigating your institution through ners opportunistically, and give top priority to the calm and the storms and safely into port. risk management is a sine qua non of success. Chapter 2 covers the practical side of building Aleksander Weiler, CFA a portfolio of alternative investments. We dis- cuss building portfolios based on fundamental economic drivers rather than conventional asset class definitions or statistical constructions. Chapters 3 through 6 cover the specifics around 2009 G BEST PRACTICES IN ALTERNATIVE INVESTING: 4 R Table of Contents Chapter 1 – Building A Successful Portfolio Of Alternatives ...................................................... 7 What Are Alternative Investments? ....................................................................................7 Why Consider Alternatives? .............................................................................................. 7 Common Characteristics Of Alternative Investments .........................................................8 Hedge Funds ...........................................................................................................9 Private Capital ........................................................................................................9 Real Estate ............................................................................................................10