Investors to grow allocations to alternatives
More than 35% of institutional investors intend to increase their exposures to alternative asset classes, according to data from Preqin.
This comes as almost a third of these investors have grown their investment teams sourcing private equity, hedge fund, real estate and infrastructure opportunities over the past two years. Just 4% of investors had decreased the size of their alternative assets team over the last year. A growing number of pension funds, for example, are being forced to invest in alternative asset classes, in order to meet their ever growing liabilities.
Investors are most satisfied with private equity with 51% feeling positive about the asset class. However, investors into hedge funds are the least satisfied with 27% complaining that their hedge fund investments had fallen short of expectations. Twelve per-cent of private equity investors and 9% of hedge fund investors said the asset classes had surpassed expectations.
Private equity has displayed solid performance over the last few years. Preqin said the average private equity fund delivered returns of 18% for the one-year period ending in December 2013. Over a ten-year period, private equity has produced median net internal rate of returns (IRR) of 20%, said Preqin. Sixty-seven per-cent of respondents said they planned to make their next private equity commitment by the end of 2015.
Nonetheless, there are challenges to private equity. Regulation was cited by 30% of allocators as their biggest concern for the private equity industry. Passage of the EU’s Alternative Investment Fund Managers Directive (AIFMD), which will force AIFMs including private equity firms, to appoint a depositary-“lite” if they wish to continue marketing within the EU, is causing alarm. Solvency II, which will force insurers to hold 49% in capital for any investment in an alternative asset class such as hedge funds and private equity, is also a major issue.
While the majority of respondents felt the interests of general partners (GPs) and limited partners (LPs) were aligned, a sizeable minority felt the contrary. Thirty-seven per-cent of investors told Preqin there was a lack of alignment of interests between LPs and GPs, a 14 percentage point increase since 2013.
Management fees continue to be an area of contention with 54% of allocators stating fund terms needed to be improved. Regulators are taking note of fees and expenses at private equity firms too. A speech in May 2014 by Andrew Bowden, director of the Office of Compliance Inspections and Examinations at the Securities and Exchange Commission (SEC), identified potential conflicts of interest between private equity firms and their investors over fees, expenses and portfolio company valuations. There are concerns at the SEC that some private equity shops are charging investors unfairly for expenses.
The SEC has recently been questioning private equity managers about their deals and fees dating all the way back to 2007. There is speculation the US regulator could clamp down on private equity fees following its announcement back in 2013 that it would be reviewing the fees and expenses’ policies at hedge funds amid concerns that travel and entertainment costs, which should be borne by the 2% management fee, were in fact being charged to end investors.
The amount of capital committed by GPs remains an issue with a quarter of investors citing this as something that needed to be improved. Nonetheless, the proportion of investors complaining about this has fallen by 11 percentage points since August 2013, indicating improvements have been made.
Hedge funds, however, have not enjoyed similar levels of performance as private equity. While the asset class had a strong showing in 2013 with gains of 8%, returns in 2014 have been lacklustre with the average manager delivering gains of 2.43%, according to data from Hedge Fund Research in Chicago. However, this has not deterred investors with 89% informing Preqin that they planned to maintain or increase their hedge fund exposure over the course of the year.
Performance was cited as the most important issue by hedge fund investors, although most allocators appear to be long-termist in their approach. “Institutional investors are committed to investing in hedge funds for the long term and short-term bumps in performance numbers can be tolerated if longer term performance objectives on a risk-adjusted basis can be met,” said the Preqin report.
Thirty per-cent of investors identified hedge fund fees – the 2% management fee and 20% performance fee – as a continued gripe, particularly given the substandard returns delivered by managers. Despite all of the talk about downward pressure on fees, the traditional hedge fund fee structure appears to be holding its ground.
A survey of investors by the capital introductions arm of Goldman Sachs Prime Services found the average management fee to be 1.6% and the average performance fee to be 18.1% in 2013, a marginal drop from 2012. A survey of clients by law firm Seward & Kissel reached a similar conclusion, finding management fees stuck around 1.6% while performance fees continue to be pegged at 20%.
Regulation featured highly, with 30% of investors telling Preqin it was an issue, an increase from 24% in December 2013. Nearly half of investors view regulation as a force for good as it will afford them enhanced protection and transparency. However,35% remained unsure. A number of fund managers, particularly in the US, have delayed implementing AIFMD as they wait for greater clarity on the rules. US managers are frustrated at the Annex IV reporting obligations and requirements that they disclose remuneration packages of senior executives under AIFMD. Hedge fund investments derived from Europe pale in comparison to the US, which is a further deterrent to complying for non-EU managers.
“Institutional investors around the world are generally very positive about their investments in alternative assets at the moment. Although hedge funds have not had the best start to 2014 in terms of returns, all four main alternative asset classes are generating solid performance figures over longer investment horizons, and as a result investors are mostly satisfied with their portfolios,” said Andrew Moylan, head of real assets products at Preqin.