Alternative Asset Classes
Investments outside of the traditional mix of publicly traded equities, bonds, and money market instruments are generally referred to as alternative assets. These alternative investments include hedge funds, private equity, real estate, timberland, commodities, and collectibles. They pose interesting problems for portfolio risk analysis. While this is a diverse set of assets, two common features are low and unreliable levels of liquidity for the assets and limited information on transaction prices.1 Some issues that are of primary interest in risk analysis of these assets are stale or smoothed valuations due to lack of current market pricing; style drift caused by the greater latitude given to some alternative asset managers; selection, survivorship, and backfill biases in available price records; and greater tail-area risk than is present in more traditional asset classes.
Section 13.1 discusses risk measurement for alternative assets with smoothed or stale price records. Section 13.2 discusses time-varying risk in alternative asset returns. Section 13.3 looks at return biases associated with incomplete records of transaction prices. Section 13.4 looks at measurement problems associated with infrequent repeat sales or large quality differences associated with different transactions—problems that plague collectibles.
Measuring the true risk of a portfolio consisting of positions in illiquid assets poses considerable difficulties. One problem is that the observed prices of various assets might be determined at different times. This is a variant of the nonsynchronous pricing problem discussed in chapter 2. A related issue is that the prices themselves may not be transaction prices but rather estimates of what a transaction price would have been if a
1 Commodities can be an exception. One way to gain exposure to commodities is
through exchange-traded futures contracts rather than through ownership of physical
commodities. Exchange-traded commodity futures are often very liquid and therefore
exhibit few of the measurement problems associated with other alternative investments.