Alternatives industry to grow ten-fold in next 20 years

The global alternatives industry will grow ten-fold over the next 20 years as institutions increasingly pile into the sector, particularly hedge funds. “The market for alternatives vehicles will be 10 times larger over the next two decades. The growth in hedge funds will be driven by investors seeking diversification, high returns, uncorrelated returns and capital preservation,” said Randall Dillard, co-founder and chief investment officer at Liongate, the $2.1 billion fund of hedge funds recently acquired by Principal Global Investors, speaking at the London School of Economics (LSE) Alternative Investments Conference.

Growth in hedge funds’ Assets under Management (AuM) is being driven by institutional investors, which tend to write far larger tickets than traditional hedge fund investors such as funds of funds, family offices and high net worth individuals. A recent study by Barclays Prime Services predicts hedge funds will see $80 billion of inflows in 2014, of which 60% will be from institutional investors.

Public and private pension plans will account for nearly half of that institutional capital. Dillard highlighted pension plans had little choice but to put cash to work at alternatives if they were to meet their ever-growing liabilities. Hedge funds rebounded in 2013 with the average manager posting returns of 8.7%, according to the Chicago-based data provider Hedge Fund Research. This comes after several years of lacklustre returns. Investors are piling into the asset class with 30% of institutions telling a BlackRock study that they planned to increase their hedge fund exposure over the course of 2014.

That same BlackRock survey found 49% and 40% of allocators intended to bolster their investments in real estate and real assets respectively. The growth of regulated alternatives such as ’40 Act hedge funds will also be a major factor behind the growth of alternatives vehicles’ AuM, added Dillard. “The retail investor base is a tremendous growth area.

We are talking about a multi-trillion dollar market, and it is a market that beta hedge fund managers can access,” he said. Twenty-nine per-cent of allocators told Barclays Prime Services' study they planned to add regulated or liquid alternatives to their portfolios in 2014, a 6% increase from 2013. A number of service providers are bullish on the future of liquid alternatives with Citi Prime Finance saying it expected $939 billion of the $12.8 trillion in retail assets available to flow into liquid alternatives by 2017. One of the key investor targets among managers running regulated alternatives is the Defined Contribution (DC) pension plan market. A report by SEI said 60% of the DC plan market’s $5.1 trillion in assets were parked in mutual funds, adding this investor class had historically been averse to alternatives.

The SEI report said plan sponsors had become emboldened and were increasingly investing in real estate, inflation protected treasuries and commodities in search of greater yield. 40 Act hedge funds are not without their challenges. While the distribution benefits are hard to falter, 40’ Act hedge funds are subject to onerous restrictions. The absence of leverage (capped at 33% of gross assets), lack of performance fees (with a management fee of between 70 bps and 1%), restrictions on investing in illiquid assets (capped at 15% of AuM), rigorous corporate governance standards and mandatory third party custody will all lead to higher compliance costs, at a time when profits are rapidly receding.

These costs could also make it unsustainable for smaller hedge funds to launch regulated products. Some surveys indicate the excitement about regulated alternatives has been exaggerated. Thirty-seven per-cent of hedge fund respondents to a study by Aksia felt adopting a ’40 Act structure would lead to weakened performance because of the restrictions on investments. Sixteen per-cent of respondents cited there was a reputational risk of launching a ’40 Act fund and 18% felt client demand for such products was lacking. Dillard also said the recently enacted JOBS Act, which permits hedge fund managers to market and advertise their investment vehicles publicly, could lead to greater interest. Again, managers appear to be ambivalent at best towards the JOBS Act. Just 1% of hedge fund managers told Aksia they intended to advertise because of the JOBS Act, with 73% stating they had no intention of taking advantage of the liberalised rules.

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