Alternative Investment Industry Outlook for Q3 and Beyond in 2017

Introduction

With continued outperformance for hedge funds in the first half of 2017, investors across the globe looking ahead are still bullish on them, unsurprisingly a consensus toward favoring quantitative managers. Yet, beyond quants, strategy preference tremendously varied throughout the geographic regions. On the heels of enhanced allocator interest, despite the number of launches this quarter being lower than in prior quarters, the launch sizes comparatively speaking are larger. And as expected, investors still continue to exert fee pressure on managers and lower fees are becoming the new industry standard.

Investor Outlook

EisnerAmper has heard from capital introductions professionals from boutique through top-tier prime brokerage groups that all types of investors worldwide were looking at quantitative managers, with most popular managers in this space receiving the most inflows. However, besides quant, there appears to be a dispersion amongst investors when it comes to other strategies of choice.

Here are some brief takeaways from across the globe:

• U.S. investors are comfortable with the number of hedge funds in their overall portfolio and are looking to replace managers who aren’t performing. Strategies of appetite included fundamental, systematic and emerging markets, due to the inefficiencies that exist.
• For Europeans, funds that employ environmental, social and governance (“ESG”) investing appear to be a big theme due to concerns about environmental sustainability.
• In the Middle East, dominated by Sovereign Wealth Funds, there is favoritism to the large blue chip managers although some have invested in some high-profile $1 billion plus spinouts. Regarding strategy, they are looking at Europe and Asia-based managers to diversify their heavily-focused U.S. portfolios.  Some attractive new investment themes in Asia investors are looking to capitalize on include Japan’s shareholder-friendly corporate governance reform and the China domestic consumer play.
• In Asia, long/short managers appeared to be the most popular, followed by macro.

Hedge Fund Launches

The launch pace of hedge funds has subsided this quarter comparatively speaking to other quarters. However, the launches the industry is seeing appear to be bigger this quarter.

“Although a slower than normal quarter in terms of volume of launches, the launch sizes appear to be larger than normal with three new funds, that we are aware of, that have raised/are raising over $1 billion in startup capital,” said EisnerAmper’s Financial Services Group based in New York.“The strategies are still heavily favored towards equity strategies and we believe this is a continuation of the post-Election market rally.”

Fees

Investors continue to exhibit the upper-hand with fees they are paying for their underlying managers. At an EisnerAmper-co-hosted event on the West Coast this Summer, investors, including a fund of fund (FoF)/institutional advisor, single family office and bank alternatives platform, showcased their outlook on alternatives. Unsurprisingly, the topic of fees was a big part of the discussion.

“Fees continue to see downward pressure,” said Eugene Tetlow, business development manager in EisnerAmper’s Financial Services Group based in San Francisco.  “Investors understand that a fund manager needs to keep the lights on but as the fund grows, early stage investors like to feel that they are being rewarded for getting into the fund early and expect a further break. There is no indication that we will ever return to the told 2/20 model and with increased competition from new fund strategies, 1.5/15 seems to be the new normal.” 

The three investors present had different views on how they address fees.   Since the FoF runs large long-only multi-manager vehicles in addition to hedge funds, it is used to hurdle rates that the hedge fund industry is adopting.   The single family office, who views everything on an after-fee basis, for the right strategy, is willing to pay higher fees.  Finally, the bank platform, who thought the discount on fees, especially the carry, makes a lot of sense, is willing to pay the first 2%/15% for the founder’s class shares but as AUM milestones are reached, they would hope that managers would lower their fees for these early investors.

Conclusion

If predictions hold true for the remainder of 2017, based on enhanced global investor interest in hedge funds, managers should reap the benefits, especially the new launches who are poised to debut with greater AUM compared to prior quarters. Finally, managers should still be prepared to exert flexibility when it comes to fee requirements from investors who continue to demand lower fees or special arrangements for the earliest partners.

Asset Management Intelligence – Q3 2017

• The Risk of Hedge Fund Herding and its Role in Today's Financial Markets
• Trends in Fund Administration: Consolidation, Fee Alignment and Market Transformation
• Loan Origination as an Asset Class – What Tax Issues Do I Need To Be Aware of?
• The Operational and Compliance Benefits that Establishing an Irish Fund May Have for U.S. Managers
• Alternative Investment Industry Outlook for Q3 and Beyond in 2017
• Focus on Private Funds: SEC Enforcement Priorities