Institutional investors will likely continue to increase their allocations to private equity as hedge funds are losing their appeal, but suitable investment vehicles in Asia are proving difficult to come by, a new industry survey shows.
While investor allocations to alternatives remain robust and little changed overall, investors are increasingly showing a preference for private equity over hedge funds, according to the 2019 EY global alternatives fund survey released this week.
Covering 62 global institutional investors with an aggregate $1.8 trillion under management in total, 113 hedge funds managing $2.2 trillion and 96 private equity funds managing $1.9 trillion, the poll was conducted between July and September this year.
On average, the institutional investors surveyed indicated that they allocated about a quarter of their assets, in all, to non-mainstream investments. And although hedge funds continue to make up the largest sub-category, they are quickly giving up market share, the report shows.
Insto allocations to hedge funds accounted for 40% of their alternative investments in 2018 but that is expected to drop to 33% by the end of this year, EY said. In contrast, allocations to private equity will likely rise to 25% from 18% over the period, with allocations to real estate climbing three percentage points to 23%.
“Ultimately, allocations are looking for increased yield, … [they] are obviously looking for improved returns,” Elliott Shadforth, EY Asia-Pacific wealth and asset management sector leader, told AsianInvestor.
Hedge funds also haven't performed as well as they might have, tempering their appeal.
“Muted performance, continued scrutiny of costs and competition from other products have resulted in lacklustre demand. Private equity managers have been the direct beneficiary with the majority of private equity managers reporting larger fundraises and record amounts of dry powder,” the report said.
“Whereas minimal volatility, consistently rising equity markets and low interest rates have challenged hedge managers’ returns, these market conditions have served as rocket fuel for private equity portfolios,” it added.
TREND TO STAY
Investors do not expect this trend to change over the next two to three years, having reported that they anticipate their allocation to private equity and real estate products to continue to grow, it said.
That's backed by other experts in the field who say investors are becoming a lot more discriminatory when it comes to hedge funds, amid disappointing returns and criticism over high fees.
Indeed, Jeffrey Vinik – who previously ran Fidelity’s Magellan fund – shut down the hedge fund he relaunched earlier this year due to a tepid reception from investors.
At the same time, a growing number of institutional investors, including Chinese some insurers, are showing an increasing interest in private equity investments. Hong Kong is also making efforts to build up its credentials as a private equity centre.
For all that growing demand, institutional investors may find it difficult to source suitable alternative investment vehicles in the region, including private equity.
While Asia accounts for more than one-third of global GDP output, it’s relatively under-represented from a global alternatives asset allocation perspective. A lot of large institutional investors globally are keen to allocate to alternative assets in Asia but they face difficulties, Shadforth said.
“[Fund managers of alternatives in Asia] are not as institutionalised as their European and US counterparts. They are generally smaller in scale ... and for managers that haven’t reached the critical size, [institutional investors] are not able to allocate sufficient money without getting concentration risks,” he noted.
If such funds are too small, any large institutional investors invested in them could end up making up too big a share of their investments – even if the investment is small from the perspective of the institutional investor. The upshot is that large instos could face restrictions when they want to exit a fund.
It's partly why family offices and high net worth individuals (HNWIs) have been the biggest source of AUM growth for alternative funds in Asia over the past two years, in contrast to the Americas and Europe, where larger pension funds have driven higher allocations into alternatives, the EY study shows.
And on current evidence that trends looks set to continue.
Going forward in the next two years, 47.8% of the Asia alternative fund managers said family offices and HNWIs will be the main driver of AUM growth, versus 12.5% in Europe and 28.9% in the US. The numbers for the last two years were 46%, 14.6% and 21.6%, respectively.