Alternative Investment Industry Outlook for Q2 and Beyond in 2017

HEDGE FUNDS VS. PRIVATE CAPITAL - INTRODUCTION

Following positive performance for hedge funds in the first few months of 2017, investors are expected to continue to favor them. However, investors are expected to become more selective with respect to investment strategies and also will enhance demands on their underlying managers when it comes to negotiation on fees, better risk-adjusted returns, ensuring they boast sustainable businesses, and other requirements.  On the heels of positive performance, EisnerAmper has seen a slight uptick in the number of new launches at the start of this year from the end of last year.

Meanwhile, looking at private equity,  first quarter deal flow appeared lackluster due to a continuation of nosebleed multiples and fierce competition for quality companies with portfolio value potential in almost all sectors, along with the new administration adding uncertainty to the deal market. However, the asset class is poised for a positive turnaround going forward in 2017, comparable to 2016.

HEDGE FUND STRATEGY SPOTLIGHT - INVESTOR OUTLOOK

Investors globally, both family offices and institutions, are expected to continue allocating to hedge funds this quarter and throughout 2017. However, they will look to more differentiated strategies or niche offerings uncorrelated to the broader markets and their portfolios, according to capital introductions personnel from boutique through top-tier prime brokerage groups.  Distressed credit and emerging markets were among a couple of the strategies favored by allocators.

Additionally, other strategies of interest include discretionary global macro and quantitative offerings. Finally, allocators will continue to eye long/short managers, which have historically been the most popular type of hedge fund strategy, but will exert a bias toward low-net long/short generalists due to rising interest rates and also favor sector-focused long/short managers, especially those in health care due to the defeat of the American Health Care Act, which caused health care stocks to rally.

Separately, regarding the AUM of managers, capital introductions personnel told EisnerAmper that for those investors making an initial foray into hedge fund investing, they prefer the global, more established and larger managers than the single-country, regional or sector-focused ones.  However, European investors have become more open to emerging managers managing less than $1 billion under management, due to their ability to be more nimble.

Private Equity

In addition to hedge fund strategies for capital perseveration and portfolio diversification, allocators also continue to express interest in both real estate and private equity, 2 alternative investment types particularly popular amongst institutional investors in and family offices globally, who are typically more opportunistic than the larger LPs. Despite investor interest in private equity and venture capital, both investing and fundraising have been off to a slow start.  According to PitchBook, the number of private equity investments declined for the second straight quarter to 1,368 from 1,631 in the fourth quarter of 2016; and the number of funds that closed totaled $78.7 billion compared to $96.4 billion in the fourth quarter.

Anthony Minnefor, partner-in-charge of EisnerAmper’s New Jersey and Pennsylvania Financial Services Audit and Assurance Practice, predicts that despite such recent developments, the conditions for a reasonably healthy investment and fundraising environment are present.

“Interest rates are expected to rise in 2017 but will probably stay below historical levels,” he said. “Also, private equity has produced high annualized returns in recent years, which should continue to attract strong investor interest.”

Ethan Boothe, principal-in-charge, Texas Region at EisnerAmper, added the new administration could be adding some uncertainty to the deal market and investors are working to navigate what President Trump’s “America First” foreign policy would actually mean in regards to the bets they place, whether foreign investors would lose their appetite to invest in U.S. companies, and also if future White House policies would truly penalize U.S. businesses who move or maintain certain business operations outside of the U.S.

“Certainly the roll back of some of the financial regulations put in place by the previous administration has also added to the uncertainly, yet is perceived as a positive for many in the M&A community,” he said.  “All this and we haven't even mentioned the attempt to repeal and replace The Affordable Care Act or some of the larger geopolitical issues currently looming such as North Korea, China, Russia, or Syria.  The second and remaining quarters of 2017 are likely to be a wild ride, so buckle up folks.”

Allocator Demands: Hedge Fund Fees Remain a Top Priority

The debate on hedge fund fees continue to be a hot topic for investors and play a critical role in their decisions to make an allocation to a manager(s). Not only do they want to pay lower fees, but they also demand a fee structure that is better aligned with their portfolio needs including the inclusion of hurdle rates, as well as management fees that scale down as assets grow.

EisnerAmper’s Financial Services Group, said managers continue to make fee structures more investor-friendly.

“Fees haven’t changed dramatically in the past year; however, we’re continuing to see the popularity of a hurdle rate for a regular class (not founder’s class) grow,” he said. “The most popular rate being used is the 10-year treasury.”

HEDGE FUND LAUNCHES

The number of people interested in starting hedge funds have picked up slightly in the first quarter of 2017 over the fourth quarter of 2016, according to activity from EisnerAmper’s Financial Services Business Consulting team.

In the first quarter, the group met with 25 teams that were looking to launch funds, the overwhelming majority being long/short equity (80%), with the balance being credit funds. Meanwhile, in the fourth quarter of 2016, the group met with 19 teams, half of which were long/short equity funds and the remaining half to credit funds.

For the first quarter launches, sizes have ranged between $25-$50 million and, if they are being seeded, $75-$150 million.  These new funds are scheduled to launch in the Spring or Summer 2017.

CONCLUSION

The alternative investment industry is anticipating a positive 2017 following a solid first quarter for hedge funds and investor interest in niche strategies and an expected uptick in private equity investing and fundraising, despite a slow start.  Hence, more launches are on the horizon and both new managers and existing managers alike should be expected to accommodate investor demands, especially being flexible on fees.

Asset Management Intelligence – Q2 2017

• Robo-Advisers: The Supervisory Challenge
• The Next Generation of Active vs. Passive
• Subscription-Secured Credit Facilities: Financial Reporting Considerations
• Alternative Investment Industry Outlook for Q2 and Beyond in 2017