This interest appeared with the significant capital flows into alternative strategies. Indeed, the total amount managed in alternative strategies today is greater than the amount managed before the financial crisis, and we have seen constant growth for twelve months now.
It is the current situation of the financial markets, which are marked by increased uncertainty, that is leading asset managers to turn to alternative investments. Bond portfolios are only offering very limited – or negative – returns due to the persistence of low interest rates. Some equity markets are offering attractive earnings opportunities, but given the uncertain economic, social, demographic and geopolitical situation, volatility is inevitably higher and therefore there is increased risk in portfolios. To this can be added the question marks that are appearing over certain market truths, such as the correlation between the bond markets and equities, or that between the oil price and equities, which has been negative for a long time. Today, there is no longer the chance to counterbalance risks, but rather they add up instead.
It is therefore imperative that investors concentrate on optimising the relationship between expected returns and risks taken. In view of this, an allocation to hedge funds makes perfect sense. Historically, hedge fund managers have demonstrated their ability to generate performance with lower volatility, especially when there is less visibility on how the markets will develop.
Today, it is no longer a matter for investors to ask whether an allocation to alternative strategies is indispensible or not, but rather it is one of what is the best way to make an allocation. Besides a handful of investors in a less-regulated environment, such as family offices, or those with a very long investment horizon, such as sovereign funds, the majority of decision-makers in Europe and Asia prefer regulated, liquid and transparent investment vehicles. It is therefore a natural step for them to turn towards managers and strategies that are available in a UCITS (Undertakings for Collective Investments in Transferable Securities) format.
These funds offer a number of advantages: first, their structure is defined by European regulatory authorities, meaning that, under certain conditions, they can be freely sold across the EU, in contrast to unregulated funds, commonly known as ‘offshore funds’. They also guarantee a certain level of diversification, reduce counterparty risk and prevent the excessive use of leverage. Further, they offer a level of liquidity that is much more favourable for the investor.
On top of this, the management fees are generally lower than those of their offshore counterparts and it should be noted that these fees are on a downward trend. Investors’ sophistication necessitates that fees adapt to funds’ risk-return profiles.
The answer to the question of whether a compromise has to be made on part of the performance in order to benefit of the advantages outlined above is subject to eternal debate, but, currently, the numbers do not come out in favour of this point.
Consequently, the need for diversification and reallocation of assets within portfolios are triggering strong demand for alternative strategies in Europe. Those hedge fund managers who can adapt themselves, on the one hand, to investors’ preferences, including by reducing fees, and, on the other, to regulatory constraints, will be able to attract the majority of assets. It is up to us – the professionals in selecting alternative asset managers – to identify and select the best among them.
Head of Liquid Alternative Investment