Hedge Funds, Private Equity – Global Alternatives Survey 2015 by Tower Watson
Survey statistics
- 623 entriesare included in the survey. The majority of the data (547 entries) comes directly from investment managers with the remainder coming from publicly available sources. This includes the Global Billion Dollar Club list, published by HedgeFund Intelligence.
Section 1: Asset Class Trends
Hedge Funds: Key Trends – The evolving HF landscape
Institutional investors continue to use hedge funds to access skill and build diversity into portfolios. This is particularly true at a time when beta valuations are coming under pressure, and the best way to protect value into the next phase of the cycle is through manager skill and by constructing portfolios with differentiated strategies. The hedge fund industry has come under increasing pressure in recent times with accusations of high fees and dispersed returns; and diminishing skill levels across the industry have led to benchmark returns remaining uninteresting. Notwithstanding, the top managers in the industry continue to add value and crucial diversity to portfolios. However, during the next stage of the market cycle it will be critical for hedge funds to prove their worth and diversifying characteristics as volatility picks up and investors rely more on alternatives to generate returns.
Future outlook
Large institutional investors no longer select managers based purely on talent, although skill remains the most important criteria.As the industry has evolved, investors are increasingly seeking more than just pooled fund investments from managers –focusing on partnerships around terms, strategy focus, implementation and idea sharing. In addition, research from across the industry is increasingly highlighting areas where returns comprise not only investment skill, or alpha, but also where a portion of the returns generated are often attributable to “beta”. This includes bulk beta such as equity or credit, or more esoteric, or ‘alternative’ beta, such as insurance premia, carry, volatility and momentum. The ability to break down hedge fund returns into its component parts of alpha, beta and alternative beta allows investors to more efficiently access these returns. Furthermore, this hedge fund return deconstruction process is contributing to an increased focus by advisors and investors on building their asset allocations from a more granular return-driver perspective, instead of a traditional asset class approach.
While the ‘decompartmentalising’ of return and risk drivers and the creation of alternative beta solutions is being seen as a threat to some hedge fund strategies, moving away from an asset class approach could very well lead to a larger alternatives allocation than clients held previously, often funded from traditional beta and indeed ‘traditional’ alpha. Genuine alpha remains relatively scarce and those who can access it will rightly continue to attract flows; but for those hedge fund managers who have been selling overpriced beta masked as alpha, the game is likely over.
Private Equity: Key Trends – The evolving private equity landscape
Fundraising in private equity is buoyant with rising markets allowing private equity managers to generate significant distributions back to their investors who in turn are looking to reinvest as the asset class has proven to generate positive returns in good and bad markets. The market had been somewhat bifurcated with those managers boasting exceptional short- and long-term track records raising capital particularly quickly while others took longer to secure capital. However, this trend has been less prevalent recently with the fund-raising tailwind meaning most institutional quality managers have been able to raise capital, especially in the larger end of the market.
With all this influx of capital and cheap financing with little to no covenants, pricing both in the US and Europe is reaching all-time highs. Meticulous selectivity with managers who have proven discipline in prior cycles and have a range of skills to bring to bear on their portfolio companies will become critical in the next phase of the cycle.
Future outlook
Whilst the pressure on fees will be volatile and tends to be inversely correlated with positive market sentiment, we expect continued downward pressure on fees over the long term. Part of that pressure will be from the on-going disintermediation story in private equity. This includes continued limited appetite for traditional fund of funds and increasing activity from large asset owners buying businesses directly (ie, competing with private equity managers).
The secondary market continues to mature and grow in prominence, increasing the liquidity of the asset class.
Of late, we are seeing some larger managers implement longer dated funds, targeting longer hold periods and charging lower fees than the traditional 12 year vehicles. In principle, we find this theme compelling, but note that getting the structure and incentives right whilst finding sufficient high quality businesses to warrant ownership for 10+ years will be critical. This is all part of the continued theme of evolution of the manager/ investor relationship which we expect to continue to gather momentum as the asset class matures. We expect this trend to change the nature of the private equity relationship with increased implementation options providing more flexibility for sophisticated investors. Primary fund investing will become just one tool that large sophisticated investors use to get their private equity exposure. This will be supplemented with increased co-investing, secondary activity and strategic partnerships for investors with the scale and governance to successfully execute such strategies.
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