Alternative Investment Industry Outlook for Q3 and Beyond in 2016
With the second quarter dominated by the Brexit vote, perhaps the biggest impact for the alternative investment industry which caused both immediate and longer-term uncertainty, investors are rethinking their upcoming alternative investment allocations on the heels of which strategies are expected to outperform; and which are expected to struggle. The views were mixed. Not surprisingly, Brexit inspired immediate investor interest in macro strategies, along with U.S. equities and real estate. Separate from Brexit, the outlook on equities-focused managers varied, with some slated to shy away from long/short generalists in favor of sector focused and long-biased managers while others are on target to move away from long-biased. Others are looking at more esoteric hedge fund strategies including structured credit and direct lending, the latter being profitable when banks have scaled back on lending. And on the less liquid front, besides real estate, there is increased interest amongst various groups of investors in private equity and venture capital opportunities.
Other alternative investment trends predicted for this quarter and the remainder of 2016 include more launches planned for both hedge funds and less liquid funds, on the hedge fund front, long/short equities and specialty credit, and on the latter front, new real estate-related entities and venture capital technology focused funds.
And finally, the debate on fees, along with founders' share classes, is expected to persevere with investors continuing to negotiate for lower fees in their favor and managers expected to conform.
It is not surprising that the Brexit vote prompted investor interest in macro managers.
“Brexit seems to have increased interest in macro strategies, but it remains to be seen how large the actual inflows will be,” said industry veteran Keith Danko, founding partner of Witherspoon Partners in Princeton, New Jersey.
He added: “U.S.-listed equities, especially large capitalization stocks, and U.S. real estate, again larger commercial properties, are still viewed as low-risk yet providing some minimum acceptable return. The U.S., rightly or wrongly, is still viewed as the best haven. Buying the U.S. and shorting anywhere else is a trade that has worked for 3 years now, and Brexit gave it another boost.”
Additionally, EisnerAmper has heard that some investor groups, specifically family offices and funds of hedge funds, are transitioning away from long/short equity generalist managers due to underperformance and instead are favoring sector-focused and long-biased ones. The HFRI Equity Hedge Index confirmed the underperformance amongst long/short generalist managers since global equity markets in June posted steep losses following Brexit. It returned -0.27% in June and -0.16% for the first half of 2016.
Given the underperformance of global equity markets, investors are capitalizing on more niche strategies, including structured credit and direct lending, since these managers have been able to achieve positive returns amid low or halted interest rates.
However, the $270m endowment at Teachers College Columbia University is one investor who has moved away from long-biased managers in favor of smaller more hedged managers, and in addition, is favoring less liquid opportunities such as real estate and private equity.
“Our current exposure to marketable alternatives is about 28%, but is in the midst of a fairly substantial redeployment, away from very long-biased, larger cap oriented managers towards seasoned but smaller, much more hedged managers with a heavier tilt towards SMID equity,” said Bruce Wilcox, chair of the Investment Committee. “Our current NAV in non-marketable is 8% with a fairly heavy exposure to real estate and credit, but we have recent, as yet largely unfunded, commitments to secondary private equity and health care royalties that could double that exposure. We are very attentive to making sure we believe we are very well compensated for the illiquidity.”
EisnerAmper has heard that anticipated launch activity for this quarter and the remainder of 2016 points to more fund debuts, specifically long/short equity including long-biased offerings; along with specialty credit; and on the less-liquid side, real estate and venture capital with a technology focus.
EisnerAmper’s Financial Services Group, said the firm continues to see the normal amount of long/short equity fund launches, but an increase in volume amongst specialty credit funds, which focus on funding leveraged buyouts (“LBOs”), Hollywood films, and emerging market high yield and stressed debt.
“Although the volume of new launch inquiries has remained steady, it will be interesting to see the number of funds that successfully secure the seed capital needed to begin operations,” he said.
Todd Hankin, partner in the Financial Services Group in EisnerAmper’s San Francisco office, added the West Coast is seeing an uptick in real estate launches and venture capital activity, specifically with a technology focus.
“We are seeing a significant amount of launch activity across real estate, likely due to the search for income and appreciation opportunities away from the richly valued securities markets,” he said. “Opportunities range from holding actual real estate, buying or originating real estate loans, and investing in real estate related entities (e.g., technology or software or platforms in the real estate industry) to more creative ideas such as buying options on homes.”
He added that there is a continued growth in the venture capital space, especially with a technology focus due to San Francisco’s proximity to Silicon Valley.
The debate on hedge fund fees is expected to continue this quarter and beyond with the managers being more flexible on their fee structure in favor of the investors who request they negotiate to lower thresholds.
“We are certainly seeing more flexibility with fees, including more of the fee geared toward incentive and less toward management fees,” said Jeff Parker, partner in EisnerAmper’s Financial Services Group in New York. “We are also seeing special arrangements for certain investors, such as founders’ share classes.”
Ongoing recent published reports confirmed that the hedge fund industry standard 2/20 fee structure might not be as common going forward and will likely transition to 1.5/20.
For this quarter and the remainder of the year, investors and managers are still digesting the Brexit vote and how it will impact their respective portfolios and their performance. The general consensus is investor interest going forward is leaning toward more niche hedge fund strategies, and/or favoring less liquid investments over hedge funds given hedge funds have charged high fees for lack of performance; and are actively looking at real estate, private equity and venture capital.
Asset Management Intelligence - Q3 2016