How To Survive 2015 as an Alternatives Manager

Alternative managers could continue to generate uncorrelated, strong risk-adjusted returns in 2015 if they focus on risk management, according to the Deloitte Center for Financial Services.

The firm argued investors’ concerns of hedge funds’ underperformance and record levels of private equity dry powder may be “overstated” as they have held steady performances over the long term.

“Alternatives have held true to their core value proposition of strong risk-adjusted returns and low correlation to the broader market,” Deloitte said. “The alternatives industry is still among the most nimble and adaptive sectors of the financial industry.”

According to the report, managers will need to take a more “proactive and strategic approach” to not only risk management but also managing their reputations with clients.

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“Firms understand that if managed correctly, risk management is a competitive differentiator and can be transformed into an asset that drives brand equity and provides a measurable, positive return in the form of increased asset retention and new asset flows,” the report said.

In 2015, alternative managers should strengthen their governance structures to put risk management “the very ethos” of their firms, Deloitte argued. It is also expected that firms will standardize risk reporting to evaluate and prioritize certain risks and bolster their ability to identify risk trends quickly.

In an increasingly competitive industry, the report added it would become more important for managers to not only anticipate tomorrow’s risk but also adapt and respond accordingly.

Deloitte also said the growth in non-US market investments could add significant operational risk that could take away from return on investment.

Managers would have to pay closer attention to tax, legal, and regulatory components to investing internationally and conduct proper due diligence on their financial impact.

“Alternative managers that spend a little more time up front to ensure that they have a true understanding of what they are asking the back office to do, and the risks they are taking on, are likely to do better in the long term,” the report said.

The firm also predicted more hedge funds and private equity managers would raise capital by “monetizing” or selling stakes in their companies to institutional investors. While this may open up opportunities for both managers and asset owners, Deloitte warned there may be corresponding technical and regulatory issues.

More than half of hedge funds expect pensions to increase their exposure to the asset class, according to a survey by State Street.

Of 235 professionals questioned, 55% said they expected more money to be invested in hedge funds over the next five years, primarily due to “performance challenges” to other asset classes. More than 60% expected the broader institutional investor space—including insurers and sovereign wealth funds—to allocate more capital.

“Nine out of 10 industry professionals believe hedge funds will be required to more clearly demonstrate their value to prospective investors.” —State StreetAfter a bruising year for the hedge fund industry—in which performance declined and major investors withdrew large allocations—it appears managers are not taking it lying down.

Nine out of 10 of those surveyed by State Street said hedge funds would need to “clearly demonstrate their value to prospective investors” if they were to capitalise on what is seen as a growing appetite for hedge funds.

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Regulation was cited as the chief headwind for hedge funds, with the impact of directives such as Basel III yet to be ascertained. Basel III is aimed at reducing systemic risk in financial markets but could make it more costly for hedge funds to use prime brokers. Although 42% of respondents were confident it would not hurt their businesses significantly, 29% said the directive would increase costs and 29% were unsure of the impact.

In addition, hedge fund managers predicted increased competition for assets from mutual fund strategies.

Under UCITS III regulations in Europe, several types of hedge fund strategies have become available to institutional and retail investors through a more regulated structure. State Street’s survey found that half of respondents believed these products would take more market share from “traditional” hedge funds.

The confidence of hedge fund managers was reflected in separate research from Cerulli Associates. Surveying the broader fund management industry, the company found asset managers were boost investment in product development and distribution following a period of low activity in the wake of the financial crisis.