Alternative Investment Industry Outlook for Q1 and Beyond in 2017

INTRODUCTION

The alternative industry appears to be in a position of anticipation, with investors and managers alike awaiting if and how the incoming Trump administration will impact the landscape. Putting the new Oval Office aside, at the beginning of 2017, looking at hedge funds specifically, investors expect increased consolidation, broad underperformance and for their current allocations to remain status quo. They also seem to prefer private equity. Family offices are set to be more opportunistic than institutions with respect to strategy preference but quant strategies, specifically risk premia, appears to be a favorite thus far for both investor groups.  With respect to launches, EisnerAmper sees a healthy pipeline in the start-up space, although capital raising still remains one of the biggest challenges for hedge funds. On the private equity side, it looks much less so as they are looking to put the capital to work this year.

INVESTOR SENTIMENT

Capital introductions personnel from the biggest prime brokerage firms to second tier organizations and boutique operations have told EisnerAmper that investors globally, both institutions and family offices, anticipate greater hedge fund consolidation, management fee compression and broad hedge fund underperformance, to name a few common themes for the industry this year.

Regarding their general allocation plans to hedge funds, capital introductions personnel noted that the majority of them do not plan to redeem from hedge funds or even reduce their own allocations, but are focused on replacing or upgrading existing managers rather than allocating to new ones. Further, they’re eyeing more exposure to private equity.

Looking at their strategy appetite, although preference varied amongst investors on different continents, and family offices appear to be more opportunistic than institutions, some common themes include favoritism toward various quantitative strategies, in particular quant equity and CTAs, given these offerings provide risk diversification, beta reduction and absolute return. In addition, another quantitative strategy they are all favoring is risk premia, given they offer more transparency and have lower fees than typical hedge fund structures. Further, investors worldwide are also eyeing distressed credit.

Additionally, other strategies of interest amongst institutions include “niche” offerings, with direct lending being one example or more esoteric ones; fixed-income relative value, which was popular all of last year; and finally, equity long/short and global macro, which just more recently started to pique investor attention.

On the less liquid side, there is an expected appetite for hybrid hedge fund/private equity vehicles and illiquid multi-asset class credit solutions.

Principal-In-Charge, Texas Region, EisnerAmper, confirmed that as many institutional investors have moved away from hedge funds as an asset class in 2016, there is still a strong appetite for private equity by the LP investors.

“This is driven by the steady and favorable return-on-investments and risk-profile,” he said.

Alternatively, institutions appear underwhelmed by fundamental and directional strategies looking ahead.  

In addition to quantitative offerings, especially risk premia, family offices are expressing an appetite for allocating to emerging managers and continue to be opportunistic when it comes to strategy. Some strategies of interest amongst this investor group include sector-focused offerings, either a focus on a specific area such as a health care or a multi-sector fund; and financials given their outperformance following the U.S. presidential election.

LAUNCH ACTIVITY

Launch activity this quarter and further into 2017 is expected to pick up and EisnerAmper sees a healthy pipeline of start-ups, both in hedge funds and private equity. Raising capital continues to remain one of the biggest challenges for hedge funds, while, on the other hand, private equity managers have raised capital which they are expected to put to work this year.  

“In California, we are seeing a good amount of activity in the start-up space,” said Eugene Tetlow, Business Development Manager in EisnerAmper’s San Francisco office.  “There has been a steady momentum building and a number of funds are planning to launch in the first half of the year.  In regards to AUM, the community remains cautiously optimistic that a number of these new launches will get seed deals ranging in size, but I still expect the majority to launch with less than $100 million.”

Several capital introductions personnel told EisnerAmper that capital raising for most start-up hedge funds continues to remain challenging, prompting some to postpone their launches until the second quarter or later this year.

Jeff Parker, Partner in EisnerAmper’s New York office added:  “The new year is bringing renewed optimism in the industry, as the improved market of the past few months has been joined by the potential for less regulation.  New launches seem to indicate that enthusiasm.”

In other financial centers in the U.S., the launch pipeline in the private equity space remains robust.

“Over the last 4-5 months, we have seen many new launches as a result of people spinning out of existing Florida-based private equity funds,” said Michael Mazzola, Partner in EisnerAmper’s Miami office.

“A new trend we are seeing is many GPs have raised capital and put together one-off (sidecar) ‘niche funds’ which allow LP investors to focus their investment not only with a private equity asset class, but a very specific sector or subsector based on the private equity niche and investment thesis,” Boothe added.  “Look for the continuation of a highly competitive market in 2017.  Rates are rising but remain near historical lows, so senior debt remains cheap and accessible for deals. As in 2016, there are just simply fewer quality deals on the market.  Unless the proprietary/unicorn is in play, there will be multiple players both financial and strategic that are chasing and indeed fighting over ‘good investment companies’ when an opportunity comes to market.  Furthermore, the funds raised vintage 2015 and 2016 provide significant dry powder for private equity investment partners who will be looking to put that capital to work in 2017 as that capital has defined time brackets.”

CONCLUSION

With the year only a couple of months old, it will be interesting to see if investors allocation plans for hedge fund and private equity come to fruition in 2017. And if that is the case, quant strategies, namely risk premia offerings, should receive new inflows of capital, along with private equity given its lucrative return-on-investments. Further, with planned start-ups across financial centers nationwide in the U.S., launches are on track to increase for both hedge funds and private equity.

Asset Management Intelligence – Q1 2017

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• What U.S. Fund Managers Need To Know when Setting Up an Irish Fund Structure
• A Brief Summary of the Recent AICPA Technical Questions and Answers Applicable to Investment Companies
• What Your ODD Failed to Identify: Red Flags for Allocators and Investors
• Alternative Investment Industry Outlook for Q1 and Beyond in 2017
• Mutual Funds and ETFs: A New Liquidity Risk Management Regime