The increased adoption of outcome-based benchmarking is pushing traditional asset managers to extend their investment capabilities by developing more alternative hedge-based strategies. At the same time, pure play private equity and hedge fund managers are moving into long-only products such as alternative mutual funds to capture a new investor base.
There is then, significant convergence taking place in the investment funds industry. Traditional asset allocators have long gone down the path of investing through fund-of-funds, even building their own alternative investment teams, but there is now another option being proposed: teaming up with seeders and acceleration capital specialists to build relationship-based platforms.
Such an arrangement - which can be thought of as “quasi-private equity” given the long-term nature of the investment commitment - gives investors the ability to build close relationships with underlying managers and in a sense become masters of their own destiny by co-creating products.
This is precisely what Amsterdam-based IMQ Investment Management, an award-winning seed platform and provider of acceleration capital, is looking to do with a strategic investment partner – be it a large family office, a sovereign wealth fund, pension fund, insurer or a traditional global asset manager.
“These investors have tremendous purchasing power. Two topics should be on their agenda today: how to establish closer relationships with managers and how to become more actively involved in the creation of products. Why are they investing in products being developed on the other side of the table? Why not go deeper into the value chain and become co-developers of the products they invest in?” says Jeroen Tielman (pictured), CEO and founder of IMQ.
Against this background IMQ is positioning itself as the partner enabling these investor to become “developer and manager” of a portfolio of alternative strategies. As such, it will offer a way for an investor to closely connect with external managers without the burden and remuneration costs of doing so in-house.
“Our point is that traditional asset allocators could use the skills available with seeders and accelerators to build closely aligned “impact” relationships that would not ordinarily be achievable by investing in external funds. It would enable investors to have their own alternative multi strategy suite replacing for example their allocations to external funds or fund of funds,” says Tielman.
Drivers of Convergence
The lines between traditional asset management and alternative investment strategies are blurring as alternatives are becoming increasingly embedded in investor portfolios. Anomalies like a unprecedented period of extreme low rates in a climate of macroeconomic uncertainties contribute to investors looking for consistent and uncorrelated returns – a function that used to be delivered by fixed income investments.
As a consequence hedge managers, private equity firms and traditional asset managament companies are being in the process of “converging” into each other’s business offerings as all need to expand their skill base into other ‘asset classes’ in order to be better equipped to provide total investment solutions to their clients.
One of the main drivers behind this seems to be caused by the connection investors make between the use of alternatives and outcome-based investing. From a retail point of view outcome-based investing is examplified by target date or target capital funds increasingly found in D.C. programs. In terms of institutional investor thinking, outcome-based investing can be seen in terms of their ability to generate certain cash flows over time or in terms of risk factor investing along the dimensions of, for example, interests rates, credit risks, currency risks, inflation, tail event risks etc.
“That’s their ultimate benchmark but this kind of thinking requires a broader toolset to accomplish these objectives,” says Tielman.
Another key driver is a desire among institutional investors to foster more meaningful relationships with managers.
A 2014 survey of institutional investors by McKinsey - “The Trillion-Dollar Convergence: Capturing the Next Wave in Alternative Investment” - found that larger institutional investors intend to take more control over their alternative investing activities and reduce the number of existing relationships with external managers into a smaller group with whom they have a strategic relationship.
Institutional investors appear to be mainly motivated to establish these strategic relationships as a way to build capability and secure access to specialist and differentiating strategies (which might have certain limitations in capacity) enhancing their ability to meet specific investment targets. A similar message rang true when AIMA published a study in June 2014. This too found that institutional investors are seeking more direct engagements with the (hedge) funds they invest in, resulting in ‘partnership’ type relationships.
The benefits investors seek to obtain include access to skills, customization of services, better mutual understanding, co-investments and better value for money.
“In this age of fundamental industry change there is a vast advantage looming for large entrepreneurial investors building partnership relationships with specialized, agile and extremely motivated managers providing an opportunity for the these investors to get their interests aligned with the managers they allocate to,” comments Tielman.
The seed/accleration capital platform proposition
Earlier this summer, Blackstone launched a new multi-strategy fund platform. Managed by Blackstone Alternative Investment Advisors LLC, the platform allocates assets across to a series of investment sub-advisors to effectively build out a multi-strategy platform. As the Financial Times reported, it will allow Blackstone “to take advantage of the multi-strategy platform that has allowed similar hedge funds such as Israel Englander’s Millenium to sign up traders that have been unable to launch their own”.
“Blackstone were very public about the fact that the relationship with each underlying manager is very granular. Each manager shares their trading ideas with Blackstone which would not be possible if you entered in to an arms-length relationship with managers; for example, fund-of-funds where you’re not a stakeholder in the underlying manager. That makes it harder to get aligned with the manager in such a way that they would readily share trade ideas in the way that is happening with Blackstone’s platform.
“The link with the seeder or accelerator is much stronger. They are specialists not only in defining these relationships but also managing them, which are far more intensive than just managing a general relationship with an outside manager,” comments Tielman.
The Blackstone platform is a good illustration of what Tielman is looking to build with the right strategic partner; someone who currently invests in a portfolio of blue chip hedge fund names but would like to go one step deeper in their relationship with the underlying managers.
Think about this. Citi predicts that by 2018 the hedge fund industry will have doubled to USD5.8tn of assets under management. Now, given that the biggest most well known hedge funds are closed to new investments, that’s a lot of potential capital to be allocated. This is where co-investment platforms could take off as it will provide investors with exposure to a huge segment of the hedge fund market.
“There are a lot of managers within the EUR100-500mn range where, if they could get a ticket of EUR150mn in sticky assets would be more inclined to align their interests with a capital sponsor,” suggests Tielman, “and this would apply to all alternative fund managers, not just hedge funds.”
One area that could lend itself particularly well to this long-term partnership approach is private equity fund-of-funds. Indeed, Towers Watson sees the reduction of manager fees as one of the main reasons behind the growth of strategic partnerships between managers and investors.
“As a seeder we have experience in private equity. We would look at both hedge funds and private equity funds. Any institution wishing to strengthen their position and add better value to their end investors in the alternatives space could seriously think about setting up such a platform,” confirms Tielman.
How the platform would be structured would ultimately depend on the dialogue between IMQ and the strategic partner. What is critical, and which is one of IMQ’s core strengths, is how the investor defines the partnership with each underlying manager.
The platform would be structured based on regulations, distribution, domiciliation, and legal set-up costs, as well as how operations are going to be organized. That could be in a managed account format, a fund-of-one format; it could even be an umbrella structure where each manager joins as a separate sub-fund. But as Tielman is keen to stress: “This is an execution issue. The key is making sure that how the manager relationship is defined is correct at the beginning.”
IMQ would agree with the manager on fee levels and structures, design and formulation of the investment and risk management policy, capacity rights, reporting, guiding & monitoring of the portfolio as well as the management company, manager finances, advise on the design of the governance structure, agree on aligned GP economics, define circumstances in which veto rights could be applied, agree on remuneration of key persons, monitor business development and stability of the manager; the list goes on.
Myriad benfits to the investor
All of this results in a relationship with the manager that combines the benefits of acquiring a team (insourcing) and outsourcing to an external manager. The main benefits include “better control”, upside economics, direct access to market views and trade ideas, lower costs, no ‘organizational / cultural’ conflicts, preferred access to scarce capacity, and last but not least an expedient and flexible way to expand the ‘manufacturing’ base.
What is particularly exciting with this arrangement is that if the right investment team were identified, and the investor was willing to write a ticket of EUR200-300mn, IMQ could potentially help lift that entire team out of an existing firm, provided they satisfied due diligence. This would give a trader the opportunity to set up their own operations with enough seed and acceleration capital to be beyond the breakeven point on Day One.
This would be a rare bird and certainly not the normal ‘modus operandi’ of the partnership arrangement but it would at least open the door to possibility.
“Traditional asset managers really need to find access to top talent as opposed to hiring people to build their own internal teams. It has happened in the US where alternative management teams have been incorporated into large traditional institutions resulting in culture clashes, disputes over remuneration, different back office requirements etc.
“In addition, some large asset managers are reducing their costs and only visiting external managers once a year instead of twice a year. That’s the wrong way to go. A way to save costs and be more in control is to take a step forward – not a step back - and go deeper into the relationship with the manager,” opines Tielman.
In this age of fundamental industry change there is a vast opportunity looming for large entrepreneurial investors to build partnership relationships with specialized, agile and motivated managers and mutually benefit from a tighter alignment of interests.
“My message is that seeders and accelerators are specialists in building these deeper manager relationships. For family offices, SWFs and other institutional investors, that could prove to be a valuable opportunity. It could give them the ability to provide tangible added value to their own stakeholders,” concludes Tielman.