With growth comes challenges. That certainly seems to be the case in the alternative investments industry where assets under management have grown by 40 percent in just four years as institutional and other major investors broaden their exposure to multiple asset classes and reinvest the proceeds arising from years of healthy returns.
There is little doubt about the scale of the opportunities. Preqin estimates the alternatives market now totals $7.7 trillion worldwide, with 80 percent of institutional investors investing in at least one alternative asset class.
The market is developing too. Hedge fund managers are expanding beyond open-ended fund structures to encompass close-ended funds. Meanwhile, private equity firms are looking to attract a wider set of investors by diversifying their investment strategies and improving investor servicing through technology and automation, which was once the sole preserve of the hedge fund industry.
“GPs need to make a number of carefully considered operational decisions that will directly affect their ability to maintain good relations with their investor bases” Ross Ellis
A number of alternative managers also are looking to tap into the retail market and growing numbers of traditional managers are joining the fray with strategies and fund structures designed to appeal to existing, and new, alternative investors.
With institutional investors continuing to reinvest their profits, inflows to alternatives are likely to pick up pace. Yet this growth may obscure an existential threat to managers lurking beneath the surface – a threat that may have profound implications for how alternative managers run their businesses.
Frustrated by deficiencies in transparency and reporting, and in some cases, perceived misalignment of interests as it relates to returns relative to fees, a growing number of limited partners are choosing to invest directly, circumventing working with general partners entirely.
And with asset classes converging, and as investment vehicles evolve and business models change, it is becoming more difficult to offer an attractive value proposition in an economically sustainable fashion. Attracting and retaining investors increasingly requires that managers differentiate themselves not only by their performance but also by adopting reporting, accounting and administrative processes that are both simple and effective.
In short, GPs need to make a number of carefully considered operational decisions that will directly affect their ability to maintain good relations with their investor bases and conduct successful capital-raising activities over the next decade.
In our latest paper Finding Success As Alternatives Converge, based on a survey of GPs, SEI found that institutional investors continue to exhibit a strong appetite for alternative investments but indicated that demand patterns appear to be changing. These shifts make it more critical than ever that fund managers position themselves strategically in order to maximise their competitiveness.
There is little consensus as to which type of firm is best equipped to meet the needs of institutional investors. Employees of firms involved in a single asset class are much more likely to stress the advantages of focused expertise, while firms managing several asset classes are much more likely to advocate diversified business models.
Investor expectations have changed over the years, and many GPs have heard calls for greater transparency, negotiated fees, more frequent reporting and greater access to portfolio managers. The capital-raising process has also evolved and a growing number of firms are offering customised investment vehicles with unique reporting and accounting requirements.
Many firms plan to use technology to help them meet investor requirements and disseminate the information to a progressively more sophisticated investor community. Partially as a result of automation and increased operational efficiency, fees have come down at many firms and investor onboarding times have improved. A significant number of managers are finding that they can optimise technology spending by forging partnerships with external specialists in one or more functions.
Operational characteristics that may have once been seen as secondary features are now critical items on due diligence checklists, representing the cost of admission. However, as investors and their advisors develop a growing awareness of the options available, they will no doubt continue to ask for more and develop more stringent requirements.
As alternatives converge, vehicles and strategies become less standardised and asset managers’ businesses become more complex.
Additionally, it will become increasingly critical that operations are run on integrated platforms that allow firms of all types to support their investment expertise with a streamlined and technology-enabled investor experience. Integrated platforms also give managers the agility needed to experiment with newer, innovative structures and pivot to side vehicles as the market demands.
The bar, the minimum needed just to get in the game, will be even higher tomorrow. What can asset managers do to prepare themselves going forward? A single best approach is unlikely in such a fluid environment, and managers seeking to optimise their businesses will need to focus on more than just one aspect to be in a competitive position going forward. Rather, decisions will need to be made in the context of business strategies, market positioning and investor needs. Still, it is possible to point to some best practices.
As alternatives converge and investors continue to re-evaluate their approach to investing, the most successful firms are likely to be those that select the best people and strategies from both the private equity and hedge fund worlds. Investors are becoming less concerned with artificial silos when it comes to asset classes and investment vehicles. They want to be offered solutions tailored to their needs and executed by talented teams in a timely and transparent way that meets their mandate.
The same goes for processes and systems. As businesses become more complex, it will become increasingly critical that operations run on flexible, integrated platforms that focus on investor outcomes rather than the underlying technology. Systems will need to be capable of handling closed-ended fund structures alongside more liquid portfolios. Listed securities and syndicated loans from around the world need to be accommodated alongside traditional assets. Full data transparency will be expected, with multiple systems being able to talk to one another so managers can provide insights across asset classes, structures and vehicles. More sophisticated infrastructure will also enable multi-strategy funds to customise their risk exposures.
Customised investment strategies, fund structures and investor communications should all be anticipated. Infrastructure should never stand in the way of a manager being able to launch new products, enter new markets or provide better and timelier reports. Broadly diversified managers and specialist GPs alike will need to understand that their operational capabilities form a core part of their value proposition, and ultimately, determine whether they can support their investment expertise with a streamlined and technologically supported investor experience.
Investment acumen, networking skills and self-confidence remain the key drivers of success for alternative managers. But in an increasingly crowded and competitive environment, we can add operational capabilities to the list.
This article is sponsored by SEI