If you live in, or have ever visited, New York City, you know how critical the subway system is to the proper functioning of the city. The system provides options, expedience and is cost efficient when it comes to navigation. The city could not function properly without it. However, if you were to read a news article in 1995 which was titled ‘Death of the Subway?’, you might be inclined to think that subway use or accessibility was going to be reduced drastically if not disappear. However, the truth was quite the opposite. What was actually happening in 1995 was that the subway token was replaced by the MetroCard, the now ubiquitous form for accessing the NYC subway system. Gone were the days of carrying large amounts of weighty tokens. Instead, access to the city would, from now on, rest easily in a slim card in your wallet or purse.
A corollary can be drawn here regarding hedge funds and the alternative investment industry. If you look at a news source covering the fi nancial industry today, there is a good chance you will see articles on the (exaggerated) demise or death of the hedge fund industry. These articles cite large pensions or other institutional investors pulling money from hedge funds, hedge funds winding down or the poor performance of hedge funds relative to certain broad-based indices.
However, much as a report on the death of the New York subway system would be misleading, so too are these headlines. As the NYC subway system is a necessity in a large bustling metropolis, alternative strategies are paramount to a well-diversified asset allocation model in an ever evolving and uncertain world. A hedge fund, much like the subway token, is strictly a structure which allows access to alternative strategies. In the end, that is less important than the existence and adoption of the strategies themselves. The strategies are the true lifeblood of an alternative manager’s business and what will contribute to the longterm viability of the alternative industry. As investors, we need alternative strategies to exist for well-rounded and diversified portfolios which can generate alpha and provide downside protection. Large pensions are not pulling out of long/short strategies, private equity, REITs, and arbitrage to enter back into large cap mutual funds. Allocations to those traditional strategies have already been made and accounted for within institutional portfolios. What is actually happening is that investors are changing the way they invest. And there is evidence to back that.
Recent research supports that infl ows to alternative strategies continue to be robust. A paper issued by the Boston Consulting Group in June of 20171 highlights findings from surveys conducted with 140 asset management institutions, representing $40trn – or roughly 55% of the world’s global assets. Th e study shows that alternatives are paving the way in terms of AuM and revenue growth as they relate to actively managed strategies.
In another recent report released by PwC2, it said that by 2020, alternative assets would grow to $13.6trn in the base case scenario and $15.3trn in the high case. Th is is from a current size of $10trn according to the same report from the Boston Consulting Group.3
Given this data, why do some say that hedge funds are dead? It goes back to the distinction between structure and strategy, but also includes shift ing investor demographics, changes in regulation and fee compression.
With investors – especially large ones – having gained power in dictating their own terms, assets are broadening from the common hedge fund structures to managed accounts, funds of one, liquid alternatives and customised portfolio structures. Instead of investors accepting mostly generic terms, they are able to customise agreements and investment strategies. And there is today a greater need for increased transparency, liquidity and control over assets. These factors have helped spur an evolution in the way alternatives are packaged and distributed.
Another factor impacting this transition is a shifting investor demographic. While still somewhat slower to adopt alternative products, the broader, non-institutional client base has been growing increasingly more educated on alternative strategies. This has led to growth – albeit slower than anticipated by asset managers – in liquid structures employing alternative strategies, including open-end funds,closed-end funds, exchange-traded funds and interval funds. Many of these products are the same strategies employed in hedge funds but are being made available in more liquid and tradable structures.
So why is it important to make this distinction? Because investors need alternative strategies to fulfil obligation, diversify investments and provide downside protection in the case of a market downswing. To account for this, industry participants should use the term alternative investments to refer to the broader industry, and hedge fund to refer to the legal structure. Alternative asset managers also need to have an infrastructure in place which allows them to adapt to changing investor requirements. Lastly, we need to highlight the positive flows and information around the industry.
Information has been provided to support this sentiment. According to another paper from PwC, “…asset flows away from traditional active management and towards passive and alternative strategies are accelerating.”4BNY Mellon and FT Remark also published a report that highlighted this: “As our study shows, appetite for alternatives is set to rise further over the coming years. This is the result of strong returns generated by alternative strategies, both on an absolute and relative basis.”5The future is still bright for the alternatives industry. Let’s read between the headlines and educate and inform together.
Published in HFM Week 2017 Prime Broker Report, September 2017
1The Boston Consulting Group “Global Asset Management 2017 Preview: The Innovator’s Advantage, 2017
2PwC “Alternative asset management 2020: Fast forward to centre stage”, 2015
3As of 12/31/16. Includes hedge funds, private equity, real estate, infrastructure and commodity funds, liquid alternative mutual funds (absolute return, long/short, market neutral, volatility); private equity and hedge fund revenues do not include performance fees.
4PwC “Asset & Wealth Management Insights - Asset Management 2020: Taking stock” 2017
5BNY Mellon and FT Remark Split Decisions: Institutional Investment on Alternative Assets” 2016
Aaron Steinberg is a director of sales and relationship management in the prime services division of BNY Mellon's Pershing, focused on financing and securities lending solutions for hedge funds, mutual funds and other alternative asset managers. He has almost 20 years of experience working with alternative investment managers.