January 1, 2014

How to Play Alternative Investments in 2014

Investors in hedge funds, real estate and private equity say they’re underallocated

Institutional investors in hedge funds, real estate and private equity are largely satisfied with their investments, and don’t expect to make changes to their allocations despite concerns about recent regulatory changes, according to Preqin, an alternative asset industry information provider.

More than 80% of the 450 investors across alternatives sectors surveyed in the third quarter said they expected to commit the same or more capital to their preferred asset class over the next 12 months compared with the previous 12 months.

These investors manage a combined $11.7 trillion in assets and have more than $750 billion invested in alternatives.

Fund managers can be heartened by this strong investor confidence. Indeed, they can expect significant growth over the coming year as 54% of real estate investors said they were below their target allocation. Also, 45% of private equity and 41% of hedge fund investors were also underallocated.

Hedge Funds

Hedge Fund Research, which specializes in the indexation and analysis of hedge funds, reported that hedge funds extended their 2013 gains in November. The HFRI Fund Weighted Composite Index was up 1% for the month, its 11th gain in the past 13 months. Year to date, the index was up 8.3%.

Equity hedge funds have been the standout performers on the index this year, up 12.9%, led by funds focused on technology, health care and fundamental value strategies. They are on course for their best calendar year since soaring 24.6% in 2009, HFR said.

Commodity trading advisors, which have performed abysmally over the past two years, continued to struggle in 2013, down 2.5% through September, according to Preqin. Preqin said it had observed a decline in the proportion of hedge fund investors starting new searches for CTAs.

Preqin reported that the U.S. hedge fund industry had recovered faster and more strongly than other regions, and now accounted for 73% of total hedge fund industry assets under management. The U.S. market grew by $150 billion through the third quarter.

In contrast, Europe-based hedge funds added $33 billion in assets through the third quarter.

Much of the U.S. growth could be ascribed to solid performance, a net return of 13.5%, which beat the global hedge fund benchmark of 11.1%, Preqin said. But it also came from some significant investor commitment.

New York and Connecticut are the first and third leading centers for hedge funds globally by total assets under management, with the U.K. the second largest, according to Preqin.

U.S.-based funds of hedge funds represent $508 billion in assets under management, or 65% of the capital managed by funds of hedge funds globally.

Fifty-five percent of all institutional capital invested in hedge funds comes from U.S.-based investors; discounting funds of funds, the largest proportion of this capital is invested by public pension funds.

Assets under management may be growing, but hedge fund launches fell to a recent low in the third quarter amid worries about regulatory scrutiny, especially about the recently approved Volcker Rule, according to HFR.

The third quarter saw 231 rollouts, compared with 288 in the previous quarter and 275 in the same quarter of 2012. Third quarter launches were on the level of those in the fourth quarter of 2010, when 220 new hedge funds were created.

Real Estate

Niche investing has been a growing trend in the U.S.-focused closed-end private real estate funds sector this year, according to Preqin. It reported that funds focused on specific sectors, such as senior home, student housing and medical assets, had outperformed those that invest more broadly.

Half of the funds of vintage years 2000 to 2010 that targeted niche sectors were top-quartile performers, with 81% producing above-average returns. This compared with 48% of industrial U.S.-focused funds in the top quartile, with 76% performing above average.

Preqin reported that investor appetite for sector-specific funds was increasing, as the 39 sector-specific funds that had closed as of October had raised $15 billion. This was 50% more than sector-specific funds raised during all of 2012.

Niche funds made up 37% of total capital raised by U.S.-focused private real estate funds that had closed during 2013, compared with 24% in 2012.

Private Equity

Private equity managers continued to find good investment opportunities in 2013, with the aggregate value of private equity-backed buyout deals up 19% through the third quarter compared with the same period in 2012, Preqin reported.

Fundraising figures showed an increase of 20% in the amount of aggregate capital raised compared with the same stage in 2012. A record 1,990 private equity funds were in market at the start of October, seeking to raise an aggregate $721 billion.

At the same time, the number of funds closed in the third quarter was at the lowest level in six years. Preqin said this meant that many investors increasingly wanted to place more capital with larger and more established managers.

With a record-breaking number of private equity funds competing for capital, the remainder of 2013 and beyond promises to be highly competitive for fund managers.

-- Check out more 2014 outlooks on ThinkAdvisor.

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