This report from Boston Consulting Group is a great overview of the asset management industry and shows the contribution alternative investments have made to the assets under management vs. revenue of many of these firms.
Authored by Aaron Filbeck, CAIA, CFA, CFP®, CIPM, FDP
A long time ago, in a galaxy far, far away … hedge funds ruled the world. In fact, just 20 years ago, alternative investments represented $4.8 trillion, or 6%, of global assets under management, and hedge funds constituted much of that allocation. Today, alternative investments are larger than ever, sitting at $22 trillion in assets under management, or 15% of global assets under management. Not only is the industry larger, but the makeup of this figure is more diverse than ever and, ironically, the “alternatives” banner we’ve become so comfortable with has become more of an umbrella term than a descriptor of the strategies within. In tandem, this month the CAIA Association and CAIA New York hosted a highly anticipated event, Unveiling The Future: The Next $20 Trillion in Alternative Investments, featuring a dynamic panel discussion turning the spotlight on where the next wave of capital will come from.
Source: CAIA Association, Preqin, HFR, Grandview Research. Data as of 2023.
May the Alts Be With You.
The importance of diversification cannot be overstated, as it can be inferred or directly quoted in the long-term capital market assumptions from many of the largest global financial institutions. But, as the diversity of the underlying strategies proliferates, so too do the range of expected outcomes – BlackRock provides some surprising long-term expectations, most notably projecting the median expected return for direct lending, with its relatively desirable position at the top of the capital structure, will be higher than both leveraged buyouts (bottom of the capital structure) and real estate (median return expectation of 0%). JPMorgan similarly challenges the historical assumptions many investors anchor to, notably that median expected returns for hedge funds (beta <1.0) will similarly rival U.S. equities (beta = 1.0)!
Note: comparing hedge fund returns to long-only equities without any commentary on risk or net exposure is stupid, but I’ll do it anyways!
The future is unlikely to be all rainbows and sunshine as we enter 2024 … the exit environment is stressed and many GPs and LPs are looking for alternative ways to extend the lives of their portfolio companies without realizing markdowns and lower valuations. Interest rates have also dominated most decision-making, and while nominal returns in private credit may generate … interest, the increased cost of capital weighing on the system remains a primary concern for many investors. “I’ve got a bad feeling about this” might be apropos here.
Note: Just remember your gut is not always a reliable investment indicator!
As we extend our time horizon and begin to think in decades instead of calendar years, the umbrella term “alternative investments” will likely continue to widen, and its composition continue to change. From an asset class perspective, the infrastructure opportunity is enormous and will require private capital investment if governments hope to get even close to their targets. While not an asset class, secondaries have grown in popularity for investors seeking vintage year diversification, access to certain GPs, and taking advantage of market dislocations.
On a more thematic note, distributed ledger technology and generative A.I. are both in the relatively early stages of development and broader adoption . For the former, investment opportunities will continue to mature as, ironically, the digital asset market begins to move toward more regulated and accessible delivery mechanisms. For the latter, artificial intelligence has become the new focus for many stakeholders in the alts world – not just in venture capital but also in back-office operations. These are, in fact, the droids we’re looking for.
The Sequel Trilogy: New Characters and Hopefully A Smoother Experience and Better Dialogue
The Sequel Trilogy gets a lot of hate from hardcore Star Wars fans, but I loved The Force Awakens and The Last Jedi (we won’t talk about that last one). Regardless of your opinion of the movies individually, we all can agree that the cohesiveness of the trilogy was … well, terrible. I think there are a lot of parallels between the trilogy's complaints and the democratization of alternative investments since the GFC—interesting ideas individually, but marred by poor planning, mismatched expectations, and a lack of consideration for the consumer.
From a broader asset management industry perspective, alternative investments now represent 50% of industry revenue despite not even eclipsing one-fifth of the AUM. Institutional allocators continue to be the largest buyers of these strategies, but a growing population of financial advisors serving clients at wealth management firms and banks have been increasing their allocations to these strategies. The past, present, and future of democratization of alternative investments is something we have covered extensively here at CAIA Association, including a deep dive in one of the early episodes of Capital Decanted.
Version 1.0 of the democratization, “liquid alternatives”, sought to deliver all the benefits of hedge fund strategies within the perceived safety of regulated product wrappers, such as mutual funds or UCITS. This occurred right after the global financial crisis, as many of us sought to build more resilient portfolios to protect on the downside. This was challenging, as many players took very complex strategies and retrofitted them into a wrapper that stripped away many of the factors that led to their success. You might say they were Force Ghosts of their former selves. The net result was products with low absolute returns in a raging bull market, high fees when index investing was gaining traction, and a liquidity mechanism that allowed investors to abandon ship. It’s a trap!
We can’t just throw out the entire category of liquid alternatives, which mashes up so many different flavors of strategies that are highly dependent on manager selection. However, I think there’s a lot we can learn as private markets expand their reach from institutional to the individual. As our industry attempts to do the same thing with private markets, some of the largest GPs and fintech platforms have sunk tremendous resources, time, and effort to elevate the advisor and client experience. Despite strong demand from the advisor community, they, and, in turn, their clients, face many new challenges — from access to taxes, as well as the potential for a general misunderstanding of portfolio fit.
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January 10, 2024 NYC Event: Unveiling the Future: The Next $20 Trillion in Alternative Investments
Finally, and most importantly, when it comes to investing in alternatives, education remains paramount, after all even the Rebel Alliances wouldn’t take on the Death Star without a plan. This month, CAIA was thrilled to launch a completely modernized version of its UniFi by CAIA™ Fundamentals of Alternative Investments (FAI) certificate program to the public. This was a collective effort that involved many senior professionals across the wealth management industry, including important guidance from an advisory council. In addition to a brand-new learning experience, we have taken some bold steps in rethinking the philosophy of integrating alternative investments into a broadly diversified portfolio. The unveiling of the updated FAI Certificate Program was met with tremendous enthusiasm during a packed event on January 10, 2024, in New York City!
So … what will the next $20 trillion look like? Pretty exciting! Whether it’s product innovation, new investment themes and opportunities, or new asset classes, the toolset available to individual and institutional investors is more diverse than ever.
