While the much-documented credit crisis maintains a stranglehold on financial markets, the still relatively young alternative investment industry continues to grow.
While the much-documented credit crisis maintains a stranglehold on financial markets, the still relatively young alternative investment industry continues to grow. As assets under management increase, the level of governance standards demanded by the industry has augmented, posing the question whether greater institutional influence may be creating barriers to entry that only brand-name managers can overcome.
Historically, a fund’s perceived ability to generate future returns has been paramount. However, risk management, transparency and infrastructure supported by large operational teams are steadily growing in importance, adding to the costs of fund set-up and launch. Within these parameters it is therefore becoming increasingly difficult for a smaller fund with no track record to launch successfully as institutional investors search for attractive risk-adjusted returns.
Heightened attention is also being paid to counterparty risk. Ensuring that service providers are of the highest quality is a priority not only for a fund’s manager but for investors who carry out their own thorough due diligence. In this environment, any manager preparing for a launch needs to secure a provider with a history of solid high-quality servicing. Any new entrant without a brand name would be wise to heed the advice of their peers, since recommendations will historically be based upon excellence achieved via a thorough understanding of the complexity of the business. Therefore, confidence in a fund’s service providers may well determine its attractiveness to investors and thus its potential success.
Supporting a launch and maintaining a fund through its life cycle presents challenges to service providers too. As institutional investors increasingly shape the industry, they demand higher operational and reporting standards. Technology is central to any top-tier offering, with web-based tools as well as automatic reconciliation and pricing key factors in a fund’s ability to boosts its assets. As previously stated, as investors carry out due diligence not only on a fund’s principals but on key service providers, the need for proof of competence and recognition becomes paramount.
In a difficult capital-raising environment, credit rating is also an important gauge of counterparty risk. From a financing perspective, price remains important as certain banks shut their books to new prospects. With liquidity tightening, new entrants should be prepared to pay more to a lender that can offer future stability. Again, recognition from a top-brand financier is vital for a successful launch as it aids the capital-raising process by strengthening investor confidence. With new, smaller funds already facing competition from brand-name managers, it is critical that their managers are able to demonstrate an institutionally robust infrastructure capable of navigating any market conditions.
To conclude, although markets remain fragile, the alternative investment industry has continued to grow, bolstered by the higher governance standards required by the new wave of institutional investor. Both at launch and during a fund’s life cycle, brand-name managers currently hold an advantage on account of not only their established ability to generate returns, but their expertise in areas such as industry knowledge, counterparty risk and operational excellence.
While at a disadvantage, new managers can still launch funds successfully and compete as long as they appreciate the market and its machinations fully; especially if they prove themselves a top-quality prospect inspiring long-term investment. For the service provider this presents a challenge, as scrutiny of their offering means that they stay ahead of the pack or stagnate to mediocrity.
Tom Hadley is senior relationship manager for merchant banking at Fortis Prime Fund Solutions
