The alternatives growth story is everywhere, with investors of all stripes across the world ramping up allocations in a bid to boost returns and combat inflationary pressures.
Sovereign wealth funds are turning to private markets as the inflation shock prompts them to re-examine their asset allocation, according to the 2022 Invesco Global Sovereign Asset Management Study. European insurers are too, with the ability to generate higher yields to outperform inflation in the medium to long term spurring continued allocations to private assets, noted new Cerulli research.
In the US, the California Public Employees’ Pension Retirement System (CalPERS), the country’s largest pension fund, adopted a new asset allocation mix in late 2021 that will increase its private equity investments from 8% to 13%. The fund also added a private debt allocation of 5%. With its investments in global public stocks returning -13% in the year to 30 June 2022, compared to +21.3% for private equity, a further increase in exposure to private markets is likely.
A separate Cerulli survey of US advisors found average allocations to alternative strategies rose from 10.5% in 2021 to 14.5% this year, with a target of 17.5% in two years. Reducing exposure to public markets is advisors’ top reason for using alternative investment products. Volatility dampening and downside risk protection are a close second.
And among sophisticated investors across Europe and the UK, demand for alternative investments is set to surge by 46% over the next 12 months. Alternative investment platform AssetTribe’s survey pointed to the current rate of inflation, an increasing need to diversify existing portfolios and the higher potential returns on offer as key factors driving the shift.
Hedge fund performance is a case in point. Having endured a tough period during the long equity bull market, the hedge funds industry is again showing its value. While US equity markets suffered the worst first half of a calendar year in over 50 years, more than a third of hedge funds produced gains. Overall, the HFRI Fund Weighted Composite Index (FWC) fell -5.9% – outperforming the S&P 500 by 1,600 bps and the Nasdaq Composite by 2,550 bps. That is the largest outperformance of equity markets in the first half of a calendar year since inception of the FWC Index in 1990. The investable HFRI 500 Macro Index performed even better, gaining +14.2% YTD through June.
The strong, broad-based shift towards alternatives offers two important lessons for investment funds and their fund administrators.
First, the value of a multi-asset class infrastructure to provide the support today’s portfolios need. Transfer agency, accounting and reporting systems have traditionally been specialist software solutions developed for the specific needs of segregated markets. But as asset managers and administrators have sought to create more one-stop shop offerings by expanding their services into new markets and asset classes, they risk being left with a jumble of asset-specific platforms that multiply their costs, add inefficiencies and exacerbate risk.
Integrated fund investor servicing software with end-to-end capabilities across all asset classes cuts much of that cost duplication and risk. It enhances data integrity, and improves transparency and reporting quality.
Automate where and what you can
Which leads to the second key point: the importance of cost-controlled scalability and smooth client service delivery through automation.
With progressive institutionalisation of the alternatives industry has come more onerous investment and operational due diligence examinations. Everything – from the ease of client onboarding to trade processing, P&L allocation, fee calculations and investor reporting – is under intense scrutiny. Investor servicing must be fast, accurate and, wherever possible, digitalised if firms are to attract and retain client allocations. Sustained margin compression throughout the value chain only adds to the automation imperative.
Competition for assets will increase too if fundraising slows. Alternative assets may be an increasingly large component of many investor portfolios, but the wider market jitters are having an impact. Preqin figures, for instance, indicate private equity fundraising tumbled 50% in Q2 2022 compared to the same period last year, and may slow further in coming quarters.
Cost efficiency among both investment managers and their administrators will come into sharper focus in this environment. As will the quality and responsiveness of the service firms can provide to asset owners.
Automation through a sophisticated, integrated technology infrastructure offers the best chance of success.
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Deep Pool is the #1 investor servicing and compliance solutions supplier, providing cutting-edge software and consulting services to the world’s leading fund administrators and asset managers. Our flexible solution suite, developed by an experienced team of accountants, business analysts and software engineers, supports offshore and onshore hedge funds, partnerships, private equity vehicles, retail funds and regulated financial firms. Deep Pool is a global organisation with offices in Dublin, Ireland, the United States, the Cayman Islands and Slovakia. For more information, visit: www.deep-pool.com.