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Introduction

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Best Practices in Alternative Investing: Portfolio Construction

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“By three methods we may learn wisdom. First, by reflection, which is noblest; Second, by imitation, which is easiest; And third, by experience, which is bitterest.”

—Confucius

Greenwich Roundtable members practice a different investing approach with an active management style in alternative investments such as hedge funds, private equity, real estate, and commodities. We have written on the art and science of finding, evaluating, and hiring talented managers (the three Best Practices in Hedge Fund Due Diligence white papers). We now turn our attention to building and managing a portfolio of alternative investments.
 
We entered the project with the simple notion that there is no one right way to craft a portfolio. We manage portfolios based on the needs of our institutions, not by market conventions. Also, we determine our own appropriate risk levels. Most importantly, as the Roman philosopher Seneca said almost 2,000 years ago, “When a man does not know what harbor he is making for, no wind is the right wind.”
 
The Building A Successful Portfolio of Alternatives section distills the philosophical framework behind best practices in portfolio construction into two basic principles: Collect quality partners opportunistically, and give top priority to risk management is a sine qua non of success.
 
The Policy Portfolio section covers the practical side of building a portfolio of alternative investments. We discuss building portfolios based on fundamental economic drivers rather than conventional asset class definitions or statistical constructions. The subsequent sections cover the specifics around each alternative investment grouping: hedge funds, private capital, real estate, and natural resources. In each case we discuss the various sub-styles of each grouping, issues around funding, and idiosyncrasies particular to each.
 
The final section on governance expands on some practical elements to bringing about a solid fiduciary structure. In all, we stress that we should strive to do what is right for our institution and not what others are doing.
 
Conversations on all of these topics began in 2007 and took on greater importance early in 2008 when our symposia speakers’ darker prognostications became reality. We sat down early in the summer of 2008 to begin the work of speaking to the members and friends of the Greenwich Roundtable in the same spirit we approached our other research: openness and curiosity coupled with humility as we faced the scope of the topic.
 
Throughout this site you’ll see frequent uses of “we” and “our.” These refer to investors who are responsible for managing a portfolio for an institution or themselves. It is for them that this study has been written.
 
Overall, we hope that you find this publication helpful in navigating your institution through the calm and the storms and safely into port.