The Growing Prominence Of Alternative Assets by Preqin
Following the release of the 2015 Preqin Alternative Assets Performance Monitor, this extract from the new-look publication explores the increasing prominence of alternative assets, as well as summarizing a selection of the key findings with regards to private equity performance.
The alternatives industry has not only increased in prominence over past years but industry assets under management (AUM) have also seen significant growth. Preqin estimates that AUM has grown steadily from $5.5tn in 2012 to $7.1tn as at Q1 2015. Alternatives are commanding a great deal of attention in the investment portfolios of many institutional investors across the world, which raises the question: what is driving capital towards the alternatives industry and how far can this be expected to continue? The unique benefits that alternatives offer to investors as well as the attraction of gaining exposure to uncorrelated, risk-adjusted returns may be some of the reasons attributed to the rise in prominence of the alternatives industry. Fig. 1 shows the returns delivered by each asset class using the financial statements of 100 public pension funds in North America and Europe. According to Fig. 1, private equity has outperformed listed equity, fixed income and other alternative asset classes, especially over the longer term. Moreover, within this sample, real estate has shown its value, delivering double-digit returns over the short- to medium-term periods. Although the hedge fund asset class in this sample set has not seen the same outperformance over the same periods, wider industry trends show that hedge funds have demonstrated lower volatility, delivering attractive, absolute risk-adjusted returns to investors.
Throughout the 2015 Preqin Alternative Assets Performance Monitor, we demonstrate that alternatives have shown their value in meeting investors’ objectives by providing strong, risk-adjusted, uncorrelated returns and for this reason, the alternatives industry will remain as important a consideration for investors in the future as it is at present.
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Preqin Maintains the World’s Largest Database of Alternative Assets Performance Data
With alternatives growing in size and significance within the investment landscape, it is imperative for investors and fund managers alike to be able to understand and interpret wider industry trends in an ever-changing environment. For investors, the diverse nature of alternatives coupled with their inherent differing characteristics (liquidity terms and investment horizons for example) means that direct comparisons between asset classes are particularly diffi cult. The 2015 Preqin Alternative Assets Performance Monitor is here to help. By analyzing key metrics over the entirety of our datasets, we have produced the most comprehensive overview of alternative asset performance in the market and an invaluable tool for any investor or fund manager.
Fig. 2 shows the growth in Preqin’s global coverage of alternatives performance across private equity, natural resources and venture capital, private equity real estate, infrastructure, private debt and hedge funds. With AUM continuing to grow, positive investor sentiment and the attractive benefits alternatives can offer investors, it is clear that demand for alternatives will continue to rise for the foreseeable future, with fund managers anticipated to launch new alternatives offerings to access this growing, dynamic marketplace. Preqin is here to help: with performance coverage for approximately 20,500 funds (as at September 2015) across alternative asset classes, Preqin data gives an unrivaled insight into the performance of alternatives.
Generating positive returns relative to the amount of risk is an important consideration for investors during the fund selection and asset allocation process. Such risk can be measured by the standard deviation of net IRRs (Fig. 3) and the dispersion of returns from the benchmark (Fig. 4). Fig. 3 shows the standard deviation of net IRRs (risk) and median net IRRs (return) of private equity fund types for vintages 2002-2012, with each bubble size representing the capital committed to the strategy (in $bn). Early stage venture capital funds show their inherent high-risk characteristics, being placed at the top-left side of the chart, and illustrate that such funds exhibit the highest degree of risk but have generated a disappointing median IRR of just 2% over the period 2002-2012.
Meanwhile, buyout funds across 2002-2012 vintage years make up the largest proportion of the market, and show a relatively higher median net IRR (11.0%) against the degree of risk taken on (standard deviation of 17%) compared with private real estate funds for the same vintages (median net IRR of 7.0% and standard deviation of 19%). Moreover, Fig. 4 shows the dispersion of fund returns from the median benchmark. The dispersion of returns around the median is high for alternatives funds; it is clear that careful fund selection is of vital importance for investors, hence the need for reliable data and careful due diligence.
Fig. 4 also demonstrates mezzanine funds’ dispersion of net IRR from the benchmark, illustrating how one of the attractive characteristics of mezzanine funds is their proven ability to generate relatively consistent returns across the board. Meanwhile, funds of funds also display low volatility, with 37% of multi-manager funds generating net IRRs that deviate fewer than five percentage points from the median benchmark.
Public Market Equivalent (PME)
Public Market Equivalent (PME) is an additional metric that compares private equity with public markets. Different investment horizons and liquidity periods make it inherently difficult to directly compare private and public equity markets. PME solves this issue to a large extent, allowing for comparison against any public index. Fig. 5 shows one measure of PME, the Capital Dynamics PME+ measure, and compares private equity returns against that of the S&P 500 TR (for more information about this PME and methodology, please go to page 26 of the 2015 Preqin Altenative Assets Performance Monitor). According to Fig. 5, funds with older vintages have outperformed the S&P 500 Index significantly. With the average life cycle of a private equity fund spanning approximately 10 years, Fig. 5 shows that such funds have delivered sizeable excess returns to investors relative to public equity markets. 2002 vintage funds in particular have stood out, with a median net IRR of 18.4% calculated by Preqin compared to a PME+ value of 7.3% for the S&P 500 TR. For more recent vintages that are at an earlier stage of their fund cycle, fund performance is currently trailing the S&P 500 Index. While this is of concern to investors, many of these private equity funds are at a relatively early stage of their life (the J-curve), not to mention that public markets have performed strongly in recent years.
PME methodology can be applied to various other fund types, geographies and individual fund track records. Using a slightly different method to calculate PME, Fig. 7 demonstrates the positive turnaround in venture capital performance, and shows that venture capital funds with recent vintages (2007-2011 and 2013) have already outperformed public markets using the Kaplan Schoar method (KS PME).
After years of weak performance by venture capital funds, the strategy has seen a turnaround over the past three years, and the PrEQIn Venture Capital Index has reached an all-time high as of 31 December 2014 (index rebased to 100 on 31 December 2000). This represents a significant turning point for venture capital funds: when re-based to 31 December 2007 to illustrate the time period since just before the Global Financial Crisis (GFC), the PrEQIn Venture Capital Index (156.1 index points) surpassed the PrEQIn All Private Equity Index (148.6 index points) as of 31 December 2014.
On a fund level, strong performance of venture capital funds is displayed within the All Private Equity league tables, which list the best performing closed-end private equity style funds by net IRR overall and across various vintage groups. Strong recent performance demonstrated by venture capital funds is further illustrated when comparing PME performance of venture capital with that of buyout funds. We saw that venture capital funds with recent vintages (2007-2011 and 2013) have already outperformed public markets using the Kaplan Schoar method (KS PME) in Fig. 7. This compares favorably to buyout funds where no recent vintage buyout funds have outperformed the Russell 3000 Index as of yet.