Alts managers relaxed on rising compliance costs

Alternative fund managers are confident that rising regulatory costs will not stifle growth as demand rises for the products they offer, according to a survey by State Street and data provider Preqin.

“Regulation is a challenge, particularly now,” says George Sullivan, global head of State Street’s alternative investment solutions group. “These managers are facing off with rules that are either on the brink of being implemented or, in the case of the US, happening.”

This includes rules such as the Foreign Account Tax Compliance Act (Fatca) and the Dodd-Frank Act, among others, which many expect to raise Asian fund firms’ compliance costs.

However, in the State Street survey, of the 86% of alternatives managers that expect their costs to increase over the next five years, three-quarters are optimistic that this will not constrain their growth potential.  

This is a very different view from that expressed by private banks and wealth managers in a survey published by consultancy PwC earlier this month, which estimate rising compliance costs will hit 10% of their annual revenue in two years’ time, up from 7% today.

“I’m not trying to suggest that [alternatives managers are] not concerned about the costs,” Sullivan tells AsianInvestor. “Any time costs increase, there are concerns. But they believe they will overcome it.”

This could partly be due to the fact that institutional investors are expected to allocate more to alternative assets, with a view to boosting returns in the current low-yield environment.

Overall, 41% of Asia-based institutions plan to boost allocations to hedge funds in the next 12 months, according to a Preqin survey published last week.

Real estate is also expected to attract significant inflows. Chinese insurers alone are tipped to allocate up to $14 billion in property markets in the next several years, found a survey released earlier this month by property services firm CBRE.

Such rises in investment may help alternatives firms combat increasing compliance costs, but Sullivan the fundraising environment remains demanding.

“[Fundraising is] one of the most significant challenges managers have. And I think 2008 had a lot to do with that,” Sullivan says. Since the 2008/2009 financial crisis, institutional investors have a heightened understanding of risk and return in portfolios and, as such, have higher expectations of managers.

“The due diligence managers go through now [is incredible],” Sullivan says. “And don’t forget, there are more managers trying to attract this capital. The competition to differentiate themselves is fierce. All these things make it more challenging for alternative managers.”

Nonetheless, competition may be fiercer, but so is demand for alternative investments.

“It’s tough now, but at the same time there is a need for [alternative funds],” says Sullivan. “Among the pooled assets around the world, many are constrained in terms of their earning ability. So what better way is there to earn these returns than via alternatives funds?

“There is more confidence [among global investors] that alternatives are a required tool [in their portfolios],” he adds. “This creates tremendous opportunities for alternatives managers.”

Alternatives firms should use this as an opportunity to “distinguish themselves from peers and tap into investor appetite for increased transparency and oversight”.  

For example, managers are reporting more information to investors more frequently. The State Street survey finds that 44% of managers surveyed have increased the amount of information they report on holdings, risk and performance since 2008, and an additional 16% plan to do so in the next five years.

Respondents also forecast that there will be an uptick in hybrid private equity/hedge fund products launched as demand from institutional investors for greater liquidity continues to rise. These products offer more liquidity and shorter lock-ups than typical PE funds.

In addition, merger-and-acquisition activity is expected to increase, with 10% of fund managers surveyed planning to acquire another business within the next five years, while 7% have participated in M&A in the past five years.

State Street and Preqin surveyed nearly 400 alternative fund managers globally.