How asset owners are benchmarking alternative investments
As more Asian investors turn to overseas alternative assets for alpha in a low-yield environment, benchmarking and performance-tracking of private assets has become a much more challenging task – prompting the rise in demand of powerful databases and data management systems.
“Like most institutional investors globally, applying an appropriate performance benchmark for alternative investments is a big challenge for us, due to difficulties in defining relevant market beta, including real estate, infrastructure, and private equity investments,” said Korea Teachers’ Pension Chief Investment Officer Lee Kyu-hong.
The $20 billion pension fund is striving to raise its allocation of alternative assets from 20% to 24% by the end of this year, and further to 30% by end-2025, with a focus on overseas assets.
Teachers’ Pension currently uses inflation-based performance benchmarks as proxies for real estate and infrastructure investments, as it believes these assets could hedge against inflation risks in the long term. For private equity and private debt, it uses benchmarks consisting of public equity and bond indices.
“Nonetheless, we will keep trying to develop more appropriate performance benchmarks for alternative investments in the coming years, consulting broader databases on global alternative assets,” Lee said, noting that some investment institutions have built up a strong database for these assets.
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A NEW APPROACH
“One of the challenges of benchmarking in developed markets across the region is that the indices can be skewed by very large exposures to super-prime assets that have very low liquidity, such as the Marunouchi office in Japan or fortress malls in Australia,” said Barings’ Head of Asia Pacific Real Estate John Ratcliffe. “This becomes a greater issue as yields tighten and small revaluation movements in these assets make a larger percentage change to the index.”
“With such low liquidity in these assets, many index participants are measured against benchmarks to which there are no viable means of exposure,” Ratcliffe said.
He is optimistic that the application of technology in the real estate sector, or PropTech, as well as big data utilisation across the industry, will allow for a more accurate approach.
“The rapid shift of alternate assets such as purpose-built student accommodation, multifamily accommodation, and life sciences into the mainstream, combined with a more unified focus on ESG, presents a strong opportunity for benchmarks to become more representative,” Ratcliffe said.
There are currently two mainstream methodologies for benchmarking private investments. One is to use a public market benchmark as proxy, then adding a certain percentage of premium on top, depending on the investments’ objectives. The other is to use a customised benchmark drawn from comparable data, according to Babloo Sarin, State Street’s Asia Pacific head of asset owners and official institutions.
“If an investor is just doing it as a limited partner (LP), they probably won’t go to the extent of having a customised private benchmark. If they're doing a lot of direct or co-investments, they're probably going to use a more specific private assets benchmark,” Sarin said.
He noted that asset owners generally understand the unique nature of private assets, and are asking for more specific and real-time data as they become more involved in the private market, rather than pursuing a standardised benchmark. “They're not necessarily looking for a perfect kit. They are really just looking for some indicative numbers to be able to inform them,” he said.
Even though benchmarks and data can help crack the puzzle in private assets, investors can miss out on market opportunities and sacrifice on returns if they strictly stick to benchmarks.
For example, investors often look to performance databases to compare between hedge funds, but these may not present a full picture. Survivorship bias needs to be factored in. Moreover, some of the most established funds and some of the newer, high-potential ones often choose not to report performance, or simply can’t condense their offerings to a series of historical numbers, said Lyn Ngooi, hedge fund solutions investment specialist at J.P. Morgan Asset Management.
Ngooi said their portfolios are not benchmarked against any particular hedge fund index. “Our approach to tracking a specific manager is more targeted – through constructing precise peer groups comprising high-quality players which are as similar as possible in terms of mandate, such as sub-strategy and instruments. The focus is on quality and not quantity,” Ngooi said.
“Performance data, however, is more important as a way to validate our understanding of a hedge fund, than it is on its own. We are in regular dialogue with hedge fund managers to understand their people, investment processes, and their approach, especially in challenging market conditions – coupled with extensive reference checking,” she added.