By Diane Harrison
With year-end holidays approaching and investment action wrap-up and forward planning in process, investors are bracing for change in many formats. November seems like a good time to take an industry snapshot survey of portfolio managers, wealth advisors, regulatory professionals, and the like, and ask them a single question: What do you believe is the biggest challenge faced by the alternatives industry for 2018?
The responses include some predictable answers, mostly centering on performance, performance, and more performance, typically from those individuals most concerned with delivering alpha to their constituents. However, a range of other replies prove that the alternatives industry, which includes hedge funds, private equity, mutual funds, real estate, private debt and more, has a multitude of concerns that impact the community at large.
BEGINNING WITH THE BASICS: PERFORMANCE
In the area of delivering performance, a variety of comments ranged from the succinct to the detailed. Most respondents agreed that, in 2018 just as in years past, alternative managers are going to continue to be pressured to demonstrate the value-add for investors. The robust equity market environment that 2017 is enjoying will add to this pressure, requiring alternatives managers to articulate the specific benefits their investments can add to a portfolio.
A sampling of the concerns raised by survey respondents included these points:
- There needs to be a clear justification of added alpha and dissuasion that managers are not merely taking profit from management fees and incentive fees on the back of beta in the equity markets.
- The continued discouragement of poor or mediocre returns from the industry’s top funds colors overall market perception of the value in alternatives.
- The sustained buoyancy of rising equities and corresponding lack of volatility events inhibit the ability of many alternatives managers to execute on strategies from which to extract alpha.
- Beyond the pressure the stock market performance places on alternatives, another concern for delivering on expect returns, particularly for PE and RE firms, is overall market dynamics. All of the dry powder, all the competition, all the continued fundraising, and all of the expertise out there that makes this market more efficient – how are these managers going to continue delivering high returns?
- Stated more bluntly, until volatility returns and the market consolidates; alternatives in general will be challenged to attract new investors.
AND ON OTHER FRONTS…
Outside of performance-based concerns, the industry survey reflects a variety of additional concerns on the radar heading into 2018. These range from costs and operational issues to regulations, security, and investment opportunities. There appears to be something for just about anyone involved in alternatives to worry over. Here are some of the most popular issues concerning the respondents:
- Fees: With continued downward pressure on fees dropping the average fund launch fee to approximately 1.3%, this tightening is adding to the need for new fund managers to control their costs. This concerns investors who look closely at a new fund’s ability to properly fund their needs in operational infrastructure, staffing, outsource services, and growth.
- Delivering on alpha: net performance after fees relative to applicable benchmarks—the perception that all asset classes are fully or overvalued. Investors are focused on the stock market’s record gains, so the protection hedge funds offer is a lower priority. There is the tendency to overlook this factor until a correction occurs.
- The fund size conundrum: the big get bigger and small stay smaller. Sub $500mm managers are at a huge disadvantage in pricing, opportunity and optics.
- Liquidity—perhaps too much?
- The identification of lucrative investments, original and sustainable investment ideas.
- Costly, complex regulation for start-up funds.
- Scaling issues: there exists a disconnection between large investors and wealth management platforms, which functionally need strategies that can scale and the niche strategies which naturally don’t scale and often deliver undifferentiated alpha and higher returns. The end result is that clients of large wealth management platforms often don’t have access to the best opportunities.
- Capital raising: always the small manager’s bugaboo—raising the critical amount of funds to grow.
- Trump: the continued impact on a host of issues encompassing regulation, taxes, interest rates, consumer confidence, economic growth, etc. into 2018 and beyond.
- Cybersecurity: the growing threat of hacking, records protection and management, and building/buying a defense mechanism that can withstand this risk for alternatives managers.
BUBBLE, BUBBLE, TOIL AND TROUBLE
The concerns investors feel about alternative investments aren’t constrained to that asset class, as traditional markets are also generating investment jitters. There was an interesting article that ran on Bloomberg.com in September, ‘In a World of Supposed Bubbles, Here’s What Investors Fear Most,’ that discussed the growing concern over perhaps overvalued asset prices. The average U.S. pension plan is still trying to generate a return of 7.5 percent,” Schroder Investment Management’s Remi Olu-Pitan said. “They can’t put everything in equities to generate that return, so there’s a wall of money going into debt to get that extra yield. If that starts to unravel, everything unravels and there’s nowhere to hide.”
Junk bonds, often sought for their attractive returns, are also on the bubble watch for 2018, as their riskier profile makes them vulnerable to volatility. These typically respond more violently than other assets to market shocks because investors tend to cut the riskiest bets first. As 2017 winds down and investors turn their focus to 2018, alternatives managers need to sharpen their juggling skills while keeping their eye on all the bouncing balls to maintain an investment edge.
Diane Harrison is principal and owner of Panegyric Marketing, a strategic marketing communications firm founded in 2002 specializing in alternative assets. She has over 25 years’ of expertise in hedge fund and private equity marketing, investor relations, articles, white papers, blog posts, and other thought leadership deliverables. In 2017, Panegyric Marketing has been awarded Global Fund Awards 2017 Financial Services Marketing Firm of the Year - NY, USA, Corporate Insider Business Excellence Awards 2017 Financial Marketing Firm of the Year – USA, and M&A Insider Awards 2017 Financial Services Marketing Firm of the Year – USA. A published author and speaker, Ms. Harrison’s work has appeared in many industry publications, both in print and on-line. To read more of her published work in alternatives, please visit www.scribd.com/dahhome. Contact: dharrison@panegyricmarketing.com or visit www.panegyricmarketing.com.