Asset Management Intelligence - November 2015 - Alternative Investment Industry Outlook for the Remainder of 2015 and Next Year

Despite the fact that hedge funds are expected to face the worst year since the 2008 global financial crisis, institutional investors are still interested in the alternative asset class. Looking ahead, they are reshuffling their portfolios given their concerns about interest rate risks and tight credit spreads and because they are likely overweight equities. As a result, in order to get appropriate protection in their portfolio, they are shifting toward relative value low beta types of strategies such as equity market neutral offerings because they provide diversification. On the non-strategy front, allocators continue to look at deploying capital to smaller managers, often capacity constrained given they have a unique investment edge and on the premise they often perform better than their larger peers. Finally, with respect to launch activity, hedge fund debuts are expected to continue to subside on the heels of underperformance while new offerings in the private equity and venture capital space are slated to keep increasing.

Commonfund, an over $25 billion institutional investment manager based in Connecticut focused on not-for-profit investors, is one example of a firm that is migrating toward equity market neutral strategies given their concerns  about interest rate risks and tight credit spreads.

"Everyone is overweight equities," said Kristofer Kwait, managing director, head of hedge fund research for Commonfund. "We like strategies that you can diversify within really well and equity neutral is a good example, not just because you don't have beta properties, but because you can get a lot of diversification."

He added, "If you have a neutral portfolio in the U.S. and you pair that with a neutral portfolio in Europe and in Asia, you are getting diversification. You can play on different types of styles, such as traders vs. long-term holders. You can play growth vs. value, different types of idea generation such as catalyst-driven vs. quantitative idea generation, to gain diversification."

On the non-strategy front, institutional investors are eyeing smaller managers given they often have a unique investment edge along with their ability to outperform their larger peers. Teachers College, Columbia University Endowment is one allocator who prefers smaller managers.

"There are certainly some excellent large managers, but I have a bias toward smaller managers that have a very tight, maybe idiosyncratic portfolio management style," said Bruce Wilcox, who sits on the college's investment committee. "Small, very focused, often closed, are going to make it on their performance, rather than their management fee structure."

Finally, with respect to launch activity, hedge fund debuts have tapered off slightly beginning in September while new offerings in private equity and venture capital continue to increase.

"Long/short equity hedge funds have been one of the most popular strategies to launch this year, but that trend has subsided since September," said EisnerAmper's Financial Services Group. "Going forward this year, we anticipate seeing an uptick in credit/distressed/macro funds given the volatility in the stock market."

On the private equity side, new funds are forming due to interest from high net worth individuals and family offices, along with institutional investors.

"We are seeing a lot of crossover in terms of asset class – pure play private equity or venture capital funds are losing favor to hybrid funds that invest in early-stage companies (traditional venture capital territory) and retain flexibility to also invest in later-stage rounds (traditional private equity territory)," said Todd Hankin, a Partner in EisnerAmper's Financial Services Group based in San Francisco. "We are also seeing a tremendous uptick in activity in the real estate private equity space as well as continued growth in funds that invest in online marketplace platforms that offer peer-to-peer lending with asset classes as varied as small loans to individuals, commercial and multi-family real estate loans and merchant cash advance."

With less than one quarter remaining for 2015, it will be interesting to see what allocators decide to do with their alternative investment portfolios for the following year – whether they shift them on the hedge fund side to become less equity-centric and more diversified – and if they continue to boost their private equity and venture capital exposure. Further, if the launch activity experienced during this quarter continues into 2016, the alternative investment universe should expect a big uptick in more types of private equity and venture capital offerings debut on a faster pace than hedge funds.

Asset Management Intelligence - November 2015

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