By David Frank, CFA | CEO & Managing Partner
Over Stonehaven’s 14 year history we have witnessed and played a role in many shifting dynamics across the alternative investment industry. We are well-positioned in the marketplace to see trends with a 26 person platform representing over 20 asset managers to the global investment community.
Following are the top trends we are actively discussing amongst our team members, managers, and investors.
1. Fund flows into alternative investments will continue at a strong pace.
While there might be one or more large allocators that exit the hedge fund space similar to CALPERS, the overall trend of large institutions increasing their allocation to alternative investments is likely to continue.
Portfolio construction has historically relied on the twin pillars of equities and fixed income, one typically helping offset the other in different market environments with both providing returns above inflation over a longer time horizon. However, today’s fixed income markets provide extraordinarily little potential upside to help offset a theoretical sell-off in equities with US 10yr yields at 1.95%, British at 1.60%, German at 0.49%, Japanese at 0.26%, and Swiss at 0.18%.
Institutions are likely to continue increasing investments in alternative investments that can provide more stable returns with low correlations as fixed income surrogates. Given this role, it is no surprise that return expectations have come down. Furthermore, the focus on stability has driven investors toward the largest managers with brand names. For many investors the focus on conservatism outweighs other factors.
Alternative investments are also competing for the equity allocations of traditional portfolios as institutions accept that hedge funds aren’t an asset class but an organizational structure where a large portion of the asset management industry’s top talent resides. Increasingly institutions are removing alternatives as a bucket and considering how to use alternatives across all aspects of their portfolio construction.
Niche/peripheral strategies are also likely to benefit from increasing fund flows as valuations in more mainstream asset classes encourage investors to explore further into areas such as private lending, physical asset trading, commodities, emerging markets, CTAs, etc.
2. Industry wide AUM will continue to be consolidated amongst the largest players, increasing the prize for emerging managers to break into the top echelon while at the same time it becomes more difficult to achieve.
While emerging and mid-sized managers will likely provide the most compelling returns, the largest managers are most likely to continue attracting the most capital. The biggest fund flows are coming from the largest institutional investors who prefer to allocate to the most established managers. This is further propelling a winner-takes- all environment.
This trend has forced many of the largest asset managers to focus on gobbling up talent to integrate them into platforms where they enjoy larger economies of scale. Many talented managers that would have preferred to be independent in past years are accepting the need to join larger platforms as a result of the increasing difficulty for emerging managers to raise capital, build an institutional infrastructure, and manage the complexity of global regulations.
However, there is always churn in the industry with some top firms losing momentum and a select group of emerging managers breaking through to establish reputable brands able to attract sizable capital from large institutional capital sources.
3. An increasing number of small managers are likely to shut down while an increasing number of larger managers are likely to seek GP monetization events.
With approximately 15,000 global hedge funds in business today, the vast majority likely aren’t adding enough value for their investors to exist in the first place. Recent sub-par industry wide returns also reflect that the “average” alternatives manager is underperforming expectations. Most are also sub-scale to run an institutional infrastructure. Highly fragmented industries eventually consolidate as they mature, and the alternative investment space is no different.
On the opposite end of the spectrum, we expect to see increasing monetization events for more mature managers including selling stakes to private equity firms and IPOs.
4. Managers focused on energy-related opportunities are likely to receive the most incremental focus amongst investors.
The impact of the implosion of energy prices can’t be overstated. Calling the bottom of the market and the potential pace of a recovery will dominate dialogues throughout the year. Beyond direct commodities and energy related businesses, asset classes indirectly impacted will also be a heavy area of focus including sovereign debt & currencies (both winners & losers), real estate within the US and internationally with significant energy exposure, high yield, and lending. Managers well-positioned will benefit from strong fund flows, and we expect a proliferation of new fund launches focused on the new opportunities.
5. The surging dollar, huge drop in oil, geopolitical instability, and increasing interest rates will likely increase market volatility, boosting the opportunity set of alternative investment managers.
It appears several market trends that have been in motion for multiple years are shifting rapidly as we enter 2015. Agile managers thrive in these markets. Strategies long volatility, such as CTAs and macro, are likely to attract proportionally more interest.
Event driven and activist managers are also likely to increasingly focus on opportunities outside the U.S. as a result of a combination of strong fund flows into the strategies, the increased competition in the U.S., more distressed opportunities abroad, and less competition amongst managers outside the U.S.
6. There will be continued convergence between alternative and traditional asset managers.
More alternative managers will launch liquid alts or long only products, and traditional managers will launch more alternative products. Long/short equity managers are now competing head-to-head with long-only managers for the equity bucket of institutional investors, and the same is true for every other asset class. While there are definitely unique proficiencies to shorting, skills in security selection and portfolio construction are applicable to both alternative and traditional asset management. This trend places an increased importance on the business management skills of top executives in these organizations overseeing increasingly diverse product lines with more operational complexity.
7. Overall pressure will continue to be exerted on fees with legitimate reasons for some managers to provide discounts while others maintain pricing power.
Like anything else in a market-based economy, fees are a function of supply and demand.
Negotiating fees used to be viewed as a sign of weakness, but now it is viewed as a smart business decision under the right circumstances. Founders’ share classes are increasingly mainstream for emerging managers with cut-offs based on duration since launch and/or AUM levels. Managers realize that AUM growth is a self-perpetuating cycle where it makes sense to make concessions to grow at an early stage for the right investors. Larger managers are also selectively providing fee concessions for substantial allocations and/or longer lock-ups.
Despite the overall push for lower fees, managers with consistently strong alpha production, institutional infrastructure, and finite capacity will consistently maintain pricing power. Investors that pass on outstanding managers solely based on fees may be missing compelling opportunities.
8. The increasingly complex and challenging patchwork of global private placement regulations (i.e. AIFMD in Europe) will cause most US fund managers to focus the majority of their marketing efforts domestically.
Predominantly only larger managers are willing to make the investments needed to navigate the global patchwork of regulation, increasing barriers to access global investors. This trend could create an opportunity for large FOFs who are willing to invest the resources to act as a conduit for non-US fund flows into US managers. This same trend is impacting capital raising firms where only the largest groups are investing the resources to build global capabilities. The days of “parachuting” into foreign jurisdictions is coming to an end.
9. Asset managers will increasingly embrace exposure through media channels to enhance brands.
“No media” used to be the media strategy of most alternative investment managers. The environment has changed with many managers leveraging media actively to help build their brand and in some circumstances increase the impact of activist campaigns. LinkedIn has become the social media platform of choice to connect across the industry. While Twitter is being used primarily by manager to consume content, some managers are starting to post, particularly activists. Managers are also increasingly creating their own video content to help communicate with current and prospective LPs in engaging formats. PR agencies, video production firms, and technology firms
analyzing social media data are likely to benefit alongside the managers utilizing media to enhance their brands.
10. The institutionalization of the hedge fund business will increase demand for institutional capital raising firms.
Raising capital has become increasingly difficult for emerging managers at the same time that break-even AUM levels for managers continues to increase. The decreasing percentage of capital managed by FOFs has also spread the sources of capital among a larger number of institutional investors. This means that the capital raising process requires relationships with a larger number institutions and the ability to address increasingly institutional demands.
Managers increasingly want much more than just introductions to potential sources of capital. They want an end-to-end solution to the entire capital raising process. Beyond the day-to-day sales efforts, the services most needed are strategic market positioning, sales strategy management, sophisticated pipeline tracking, analysis of fund structure options, compliant delivery of content, roadshow logistics organization, etc. Capital raising firms that have the experience building many emerging managers into large institutions are able to act as a sounding board for managers to execute growth plans. Capital raising firms that can combine deep relationships, product know-how, technology, and project management to enhance their execution ability will outperform relationship-only providers and pure-play technology platforms attempting to match managers with investors. These institutional class capital raising organizations will play an increasing role in helping build momentum behind many of today’s leading asset management firms.
Prepare for the worst, hope for the best, and count on surprises in 2015. We wish you a terrific year, and please reach out with any feedback.