It’s time for the alternative investment industry to become more transparent and client-centered, according to the CAIA Association.
The 20-year-old professional body for alternative investments announced a new set of principles Wednesday that is intended to improve professionalism in the alternative investment industry. Among other changes, the group suggests that investors look beyond the internal rate of return, or IRR, for measuring performance and shift their views on allocation.
The goal of this set of principles is to help investors implement CAIA’s prior framework for alternative investing, called the Portfolio for the Future. As part of that framework, CAIA predicted that investing in private markets was on the brink of change — and that it would become more challenging moving forward.
“It feels like a decade ago,” CAIA executive vice president John Bowman said of the framework’s March release. “We had no idea that [the market downturn] would come as rapidly and as violently as it came.”
This downturn is shifting the dynamics in alternative investing. As allocators wait for private investment firms to mark down their portfolio company valuations, they face the denominator effect. This occurs when public market returns have fallen and private investments appear to take up a larger portion of an asset owner’s portfolio, pushing those allocations beyond their set targets. This leaves some asset owners unable to re-up their investments in private assets.
While private investment valuations haven’t yet shown the decline that public markets have, they are expected to. When those valuations fall, some allocators, and their boards, may rethink the way they put capital to work in private markets.
“The need for professionalism has never been more critical,” CAIA’s report said. “Generational headwinds in capital market expectations, inflation, and interest rates combined with a voracious appetite for exposure to less liquid, more complex, idiosyncratic asset classes and strategies are raising the bar for professionals in all corners of our industry.”
According to CAIA’s new list of principles, alternatives professionals should treat liquidity as a feature, tailor sustainability efforts to clients, and treat investors as true partners.
Bowman said CAIA is hoping to push the alternatives investment industry to raise its game by giving employees proper training and credentialing and ensuring that clients are positioned appropriately for the market headwinds they’re facing.
For example, CAIA suggests that investors should move from thinking about “buckets” of asset classes to thinking of allocating based on portfolio risks. Instead of public equities or private credit, investors could think of assets in terms of growth, yield, and inflation protection.
“Asset classes are where you end up, not where you start,” Bowman said by phone. “Often the industry has it wrong.”
CAIA is also calling on investors to rethink liquidity. Oftentimes, according to Bowman, investors have more liquidity than they need, thanks to the “marketplace’s fetish” for liquidity. This viewpoint is warping how the industry treats private investments, according to the principles.
“Private investments should not be viewed as levered public investments with an illiquidity premium,” the report said. “Private investments are an extension of the investment universe.”
For investors, this means refusing to accept unnecessary illiquidity, while also being aware of the risks of investing in liquid vehicles with illiquid assets underlying them.
Performance measurement, too, should adhere to professional standards, according to CAIA. “It is a poorly kept secret that IRR can be manipulated in ways that don’t increase value or cash return to the investor,” the report said.
“In private capital, because of the complexity, it’s foolish to assume that there’s a silver bullet for performance measurement,” Bowman said. “I wish it were that simple.”
Instead, he suggests that investors use multiple measurements to assess portfolio performance while being mindful of each’s shortcomings.
According to CAIA, private investment professionals should “avoid playing games,” like engaging in small follow-on financings at large markups, selling between funds, and “other zero value-add financial manipulations.”
Above all, CAIA believes that both allocators and their general partners should focus on transparency.
“The LP needs to make sure to not chase the shiny new object, but instead to go with partners who would share this level of transparency,” Bowman said.
