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Within the hedge fund space, private equity is growing in health care and artificial intelligence, and cryptocurrency.

Alternative Investment Industry Outlook for Q4 and Early 2018

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INTRODUCTION

In the final quarter of 2017, investors continue to express interest in hedge funds, albeit with strategy preference varied amongst different types of allocators and across geographic regions. Following sustained interest in this alternative investment type, the industry experienced an uptick in new fund launches during the quarter. And further, not surprisingly, the demand for lower fees amongst LPs continues to be the new norm.

Meanwhile, on the less liquid side, private equity activity on all fronts has slowed with respect to the number of deals closed by investors, the amount of closings on the exit front and, finally, fundraising.

INVESTOR OUTLOOK

EisnerAmper has heard from capital introductions professionals at boutique through top-tier prime brokerage groups that all types of investors worldwide continue to show interest in hedge funds, although strategy preference was pretty diverse. The only consensus was amongst U.S. and Asian investors who both were bullish on prospect for quantitative strategies, a theme that has been prominent the last few quarters.

Here are some takeaways from allocators on a few continents:

  • U.S. investors continue to be more comfortable with keeping hedge funds in their portfolios. Some highlights include entities such as tri-state endowments, foundations and family offices maintaining their focus on uncorrelated niche strategies like reinsurance and willing to invest in less liquid funds with longer lock-ups. Hence, there has been an increased interest in hybrid funds with a two-five-year time commitment. In addition, on the more liquid front, they continue to look at and invest in quantitative strategies, global macro and sector-focused long/short equity managers including health care, TMT and portfolios dedicated to Europe. On the other hand, overall demand for long/short equity generalist funds has slipped based on allocator perception that it has been difficult to generate alpha in this space.
  • Asian investors are influenced by The Government Pension Investment Fund in Japan, the world's largest pension with $1.3 trillion in AUM, who has yet to invest in hedge funds except a Japan equity activist fund and has issued an RFP for a research paper regarding artificial intelligence's ("AI") impact on investing, as a foray to invest in quantitative alternative funds in the future. Further, speaking generally with Asia institutional investors, they concur that AI can be very beneficial for more efficient execution but not yet on the strategy itself. Historically, many have a track record of investing in quantitative funds. Meanwhile, Japanese retail investors are actively looking for managers who have expertise in AI. Finally, Australian investors are also actively meeting funds in this space.
  • European investors, including funds of hedge funds, private banks and consultants, continue to prefer UCITS structures, on top of the family offices who were the first group on the continent to show an interest in them due to their attractive liquidity offering. In particular, these allocators are interested in UCITS funds managed by hedge fund managers, as well as regionally focused funds. Additionally, UK investors have expressed interest in managers that actively trade volatility and merger arbitrage.

LAUNCHES

With positive inflows from investors at the start of the year, fund managers are seeing opportunities to launch new funds. According to a survey conducted by Preqin, 34% of managers surveyed in June said they have plans to launch a new fund in the second half of 2017 and further, 20% of those said they have definite intentions to launch in the fourth quarter this year.

"We're starting to see more activity now that the fall season has begun," said Jeff Parker, partner in EisnerAmper's Financial Services Group in New York City. "It's not unusual to see fourth quarter launches. Also, we are starting to see more of a private equity flavor as well as investments in new areas."

Jaclyn Greco, business development manager in EisnerAmper's Financial Services Group based in New York added: "We continue to see the largest proportion of managers launching equity strategies, both fundamentally-driven and quantitative, as well as macro strategies."

Eugene Tetlow, business development manager in EisnerAmper's Financial Services Group based in San Francisco added: "One big growth area on the West Coast is within the cryptocurrency space with Q4 promising once again to be another growth quarter."

FEES

Hedge fund managers feel that investor demand for more favorable fees continues to be a game-changer for the industry.

"The fee structures seem to be moving from the traditional '2/20' to a typical management fee (1.25-1.50%), incentive fee (still about 20%), and – because of the underperformance in the hedge fund industry – to a hurdle rate," said Philip DeRosa, managing director in EisnerAmper's Connecticut office. "It basically allows an investor to assess whether that manager can outperform a risk-free rate or a benchmark rate; meaning, if not, why pay an incentive fee to that manager?"

PRIVATE EQUITY PERSPECTIVE

Private equity activity has slowed throughout 2017, according to findings from ACG New York's and Pitchbook's 1H 2017 "Private Equity in Review," which mentioned that the number of deals closed by private equity investors in 2017 is on pace to be below the highs of the 2014-2015 timeframe, but that the deal count is still respectable.

"Deal value is quite strong, reflecting the consistently high valuations evident in the marketplace," said Anthony Minnefor, partner-in-charge EisnerAmper's New Jersey and Pennsylvania Financial Services Audit and Assurance Practice.

Other findings specified that the number of closings has declined in recent years, which appears to be consistent with the dynamics in the investment cycle, suggesting strategic buyers are hesitant to pay the high valuations and sellers are being patient and selective, waiting for the right time and price to sell. Finally, despite the fact that fundraising has slowed this year, it is still deemed healthy and predictive of the active investment by the industry, albeit more challenging to uncover viable targets.

CONCLUSION

With 2017 coming to a close, if predictions hold true, investors globally should continue to demonstrate interest in hedge funds with quantitative strategies being the biggest beneficiaries.  In addition, the alternative investment industry will see more launches this quarter and into early Q1 2018 while managers will continue to feel fee pressure from investors.


Asset Management Intelligence – Q4 2017

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.

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