Private equity, real estate and private credit are winning investor allocations, while hedge funds are losing them. That, in a nutshell, was a key finding of EY’s annual global alternative fund survey, released this week.
Total allocations to alternative investments remain relatively unchanged year over year, but the competition between asset classes continued to intensify. Following a multiyear trend, allocations to hedge funds shrunk to just 23% in 2020, compared with 33% in 2019 and 40% in 2018.
Meanwhile, investments in private equity and venture capital held steady at 26%, while investments in private credit increased from 5% in 2019 to 11% as many market participants anticipate that the coronavirus pandemic will initiate a credit cycle, creating opportunities for these managers.
Allocations to real estate increased to 26% from 23% last year.
For this year’s survey, Greenwich Associates conducted interviews from July to September with 110 hedge funds representing over $1.8 trillion in assets under management, 127 interviews with private equity firms representing nearly $2.7 trillion in assets and 73 interviews with institutional investors representing more than $1.4 trillion in assets under management.
The EY survey also found that hedge funds have been expanding their offerings, or tapping into new markets, such as private asset classes in particular, via a variety of unique structures.
Two in five hedge fund managers are currently offering co-investment vehicles or best-idea portfolios, and one in five are creating side pockets that allow investors an election to participate in illiquid investments within a broader portfolio.
Special-purpose acquisition companies came into their own last year, EY reported, with a nearly threefold increase in the amount raised in SPACs compared to 2019.
It noted that managers have found these types of permanent capital structures an attractive way to raise capital, acquire companies and fast-track them toward the public markets.
The survey found that the alternative funds industry met investors’ expectations and managerial performance during the market volatility that resulted from the coronavirus crisis, with 58% of hedge fund investors and 81% of private equity allocators nodding approval.
Not only that, nine in 10 investors said their managers had met or exceeded client service expectations across risk management, business updates and investor reporting.
Eighty percent of allocators said the remote environment had caused little or no disruption to the engagement and due diligence of existing and prospective manager relationships.
For their part, alts managers said they expected 32% of their back- and middle-office professionals to continue working remotely after conditions normalize, as well as 28% of front-office professionals.
The coronavirus has accelerated many of the digital trends of recent years that have become critically important for alternative managers, EY reported.
Fifty-three percent of investors reviewed hedge funds favorably, saying the industry was ahead of the curve from a technology perspective relative to other financial services. The favorability number dropped to 30% for credit and 28% private equity.
Despite these advancements, EY said, there is room for improvement when it comes to automating certain functions.
The marketing and investor relations functions have largely maintained their status quo as a manual-intensive process. Although a high-touch personal experience is needed, that experience can be enhanced by technology and meaningful investor reporting.
Given the challenges posed by the altered environment with creating new relationships, and the acknowledgment that existing relationships are demanding an enhanced client experience, managers cannot afford to neglect the transformation needed, it said.
The ESG Opportunity
Forty-nine percent of allocators are currently investing in environmental, social and governmental products and socially responsible investing, nearly double the number that included ESG products in the portfolios in 2019, according to the survey.
In addition, a quarter of allocators are required to allocate to socially responsible products, nearly double from last year. EY said this trend was being driven by investors outside the U.S. — 85% of all investors in Europe either are required or expect to be required to invest in ESG products in the next two years.
But even though socially responsible investing is a promising avenue for growth, the survey showed that alts managers are not keeping up with the demand. Only one in five managers currently offer ESG products, the same as last year, and about half systematically include ESG risk factors in their investment process.
Seven in 10 investors surveyed said an alt manager’s internal ESG policy was critically important to their investment decision, way up from 27% that said this in 2019.
EY noted that some two-thirds of private equity managers currently have an ESG policy, compared with only half of hedge fund managers.
The survey found that alts managers prioritize talent management, with 42% of hedge funds and 31% of private equity firms considering improved productivity and engagement their No. 1 priority.
From here, however, their priorities diverge. Fifty-six percent of private equity firms have prioritized increasing gender representation, and 24% have made it the top priority. In addition, 52% counted increased ethnic minority representation as a top three priority.
Hedge fund managers ranked implementing strategies to increase gender and ethnic diversity lower on their list of priorities, with 26% of managers reporting increased gender representation and 18% reporting increased ethnic minority representation as a top three priority.
Nearly all investors, on the other hand, said a manager’s diversity and inclusion policies played a role in their decision to invest. Sixty-nine percent of those surveyed maintained that increased diversity leads to positive performance, and 57% said they specifically ask to review the actual diversity composition of their managers’ workforce.
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