As Investors Search for More Alternatives to Boost Returns, Private Equity Tops the List

Institutional investors complain about not finding the right opportunities, terms and possible partners, particularly when investing in private equity, real estate, infrastructure and hedge fund deals.

Institutional investors are ramping up their appetite for alternatives, including exotics such as unlisted infrastructure and private debt, but continue to be dissatisfied with hedge funds, according to Preqin’s H1 2017 Investor Outlook.

The study also found that institutional investors are looking to invest in a wider range of alternative asset classes. One-third of investors now commit to four or more asset classes, up from one-quarter a year ago, while almost one in 10 invest across all alternatives, the study found.

More specifically, Preqin said 9% of institutions invest in all six alternative asset classes, one-fifth have exposure to five or more, and over one-third (34%) invest in four or more. This represents a notable increase over the past 12 months: a year ago, only a quarter of respondents invested in at least four asset classes, and just 13% had exposure to five or more separate markets. The six alternative asset classes are hedge funds, private equity, real estate, infrastructure private debt and natural resources.

Driven by the need to diversify and generate higher returns, there is now more than $7.7 trillion in hedge funds and private capital managed globally. This is an increase of $300 billion during 2016. “Participation in multiple alternative asset classes is now the norm for the majority of institutional investors, with alternatives portfolios becoming more and more diverse,” Preqin said. But this growth in alternatives is not equal among all the choices.

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First, institutional investors have too many choices. Preqin said there are almost 18,000 alternatives funds open for investment, “but for investors, finding the true outperformers is a difficult prospect, particularly when the majority is finding that the marketing documents they receive are not meeting their needs.”

On a sector basis, the most popular alternative allocations (based on survey respondents) are real estate (61%), private equity (57%), hedge funds (51%), natural resource (40%), private debt (37%), and infrastructure (36%). Of these, the sectors which have been designated as reducing allocation in the next year are hedge funds (31%) and natural resources (23%), followed by small reduced allocations in the range of 6% to 11% for the other alternatives.

When it comes to both institutional investors and their alternative asset managers having their goals aligned, private equity ranks at the top, while hedge funds again get the lowest survey ratings because investors “decided not to invest in a fund due to the proposed terms and conditions.”

When it comes to making an actual investment, institutional investors complain about not finding the right opportunities, terms and possible partners. This is most critical when investing in private equity, real estate, infrastructure and hedge fund deals, the survey said. This happens despite the proliferation of offering documents investors receive monthly. The report found that investors receive 20 documents a month from hedge funds, and 17 from private equity and real estate managers. The quality of these documents was also rated and found that materials from infrastructure and real estate deals most often “met the needs” of investors. Natural resources and real estate documents were rated on the opposite side of the needs spectrum. .

Private Equity: The Darling of Alternatives in 2017

Of all the alternatives, private equity has moved to the top of the list in terms of institutional interest. “As we move into the first half of 2017, institutional investor sentiment towards private equity is more positive than ever,” the study said. In this category, 84% of institutional investors had a positive view of private equity, up from 59% two years ago. On the downside, 70% of respondents said fund managers “may be overpaying for assets which could be difficult to realize if prices fall at a later date.” Investors also were concerned about the exit environment (51% of respondents, up from 24% this time last year) and deal flow (41%, up from 34%).

The future also looks good for this sector, with 89% of investors looking to invest the same amount or more capital in private equity in 2018, while 76% plan to make their next commitment in 1Q 2017 and 7% intend to do so in 2Q 2017. An additional 11% plan to invest in the second half of 2017, and only 6% expect to wait until 2018 or later for their next commitment.

On a geographic basis, investors think the best opportunities for private equity worldwide are in North America (61%), Europe (44%), Asia (21%) and emerging markets (19%).

By Chuck Epstein

It seems that active management is on the wane, with a recent report from Moody’s Investors Service, for one, finding that passive investing through index funds and ETFs will be predominant in the US by 2024. Greenwich Associates, however, expects that active management still has a role in the future.

According to the Stamford, Conn., financial research firm, investors are moving their funds to passive avenues as a result of active managers’ not being able to outperform benchmark indices after accounting for manager fees. “These results have caused many industry pundits to conclude that some markets—particularly highly liquid markets like US equities— no longer provide sufficient opportunities for alpha generation. As such, they believe the best way to invest in these areas is through passive strategies that deliver market exposure at the lowest possible cost,” Greenwich reports .

And this move to active management is not tied to the economic cycle, but is more of a fundamental long-term trend. However, there remain some justifications for active management to continue to thrive. For instance: the overall growth in the money that institutional investors worldwide have available to invest. Also, not all markets are amenable to passive investment strategies. Some of them remain “complex, opaque and illiquid” and active management can play a bigger role here, Greenwich says.

Active managers can continue to deliver value by developing new strategies. And active managers can take advantage of “new distribution and client engagement models” to facilitate their client interactions, Greenwich says, nothing that although the profit margins for active management have been declining, they are still healthy compared to those for other industries.

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Greenwich expects that not all active managers will be winners though, and the move to passive management will also pose a threat to some. Those who will emerge winners will have the advantage of working with clients in a complex area where they have some special insight or superior information. They could also help their clients with intricate challenges and add value in a way that justifies their cost.

Those who will not be successful will “stick to traditional, product-centric approaches.” For instance, there are a number of asset classes that are becoming more liquid but that institutional investors don’t see as offering much opportunity to generate excess returns in, on a risk-adjusted basis. These managers would be better served by developing ways to differentiate themselves or going for new products in other areas.

Morgan Stanley also expects that it’s too early to sound a death knell for active management. Lisa Shalett, Morgan Stanley’s head of investment and portfolio strategies, wealth management, blogs that while active managers have had a tough time in the past several years, as money flowed to passive management strategies following the financial crisis, it’s likely that better days are ahead.

Shalett says, “We are in the early stages of a major regime shift, from monetary to fiscal policy; deflation to inflation; and low volatility to high volatility. History suggests that this is when active managers have the best potential to find mispriced securities and earn their keep.”

By Poonkulali Thangavelu