Trends Watch: Diversification

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Daniel Zwirn, CEO and CIO, Arena Investors, LP.

What is your outlook for alternatives?

“Alternatives” is too broad of a label given the explosion in the number of products that have emerged to meet investors’ demand for higher returns.  And to deal with that explosion of choices, there has also been an ever-increasing specialization of these strategies – i.e., what started as alternative fixed income then became long/short or multi-strategy or private credit; then private credit became direct lending or distressed lending or specialty lending, and then specialty lending became things such as trade finance funds, litigation finance funds, and so forth.  The unprecedented amount of capital flowing into these narrow investment opportunities is employing “hammers that only see nails” – i.e., once capital is committed, there is every incentive for the manager to put that money to work within their narrow mandate — without regard to the pricing or the myriad of other options that could be pursued instead.  “Overdoing” has been at the root of most financial disasters consistently for several hundred years – and this time will be no different.

What is your outlook for the economy?

My only definitive view on the economy is that we need to hedge our investments from our needing to have any view.  The monetary authorities continue to force down risk-free rates, which in turn means that risk is not appropriately priced into liquid markets (that trade at a spread to risk-free), and then also for illiquid markets (that trade at a spread to the supposedly liquid markets).  And many products are further increasing downside risk through structural leverage.  It’s a powder keg.  But at the same time, markets can be wrong for longer than an investor can be solvent -- so we believe in a much more micro view, avoiding correlation to the cycle by assuming process-oriented risks versus market-oriented or value risks in each individual investment, and then we feel it’s better to be extremely diversified by both number of positions and also the relative lack of correlation amongst those positions. 

What keeps you up at night?

It doesn’t keep me up at night given we avoid being exposed, but I do think the next downturn is likely to be worse than most people expect due to several secular changes that have occurred since the last crisis.  I wrote about these in a recent paper published in the Journal of Fixed Income  -- and if that’s correct, I expect we will be spending the majority of the rest of our investing careers cleaning all of it up.