The short-term outlook for liquid alternatives in Europe remains pessimistic, but the promise of uncorrelated returns is expected to boost demand over the medium term as investors diversify their portfolios, according to findings from the latest issue of The Cerulli Edge—Global Edition.“Net new flows of liquid alternatives in Europe will likely be negative for a second consecutive year in 2020, although net new outflows are expected to moderate in the latter part of the year,” says Andrius Dovydavicius, a research analyst with the European institutional team at Cerulli Associates.
However, Cerulli believes that the greater transparency provided by liquid alternatives, falling fee levels, and the promise of uncorrelated returns will boost demand over the medium term as investors diversify their portfolios. In addition, the COVID-19 crisis will lead to greater dislocation in financial markets, creating opportunities for liquid alternative managers.
European liquid alternative assets under management stood at EUR356 billion (USD431 billion) at the end of September 2020, representing a 15 per cent decrease from the beginning of the year. Net outflows exceeded EUR21 billion for the year, although withdrawals declined significantly to EUR1 billion during the third quarter.
Although, on average, liquid alternatives fared better than traditional investments during March’s bear market, financial markets’ quick recovery left liquid alternatives delivering weaker performance than traditional investments.
The industry’s overall interest in private assets is resulting in traction for liquid alternative funds focused on real assets. Cerulli expects this interest to remain strong, with demand likely from private banks and wealth management firms.
Cerulli is advising managers to reassess their liquid alternative product shelves, closing funds that have failed to deliver value for investors. Managers should also incorporate environmental, social, and governance (ESG) factors into their investment process. ESG liquid alternative funds have fared better than the overall liquid alternative industry.
“We believe that the sector will stabilise. However, managers will need to adapt to asset allocators’ shifting preferences to succeed,” says Dovydavicius.
Although European liquid alternative managers have enhanced their investor-relation capabilities since the Great Financial Crash and institutionalised their operational procedures, further adaption is needed. According the Alternative Investment Management Association, 53% of European managers are looking to optimize their use of digital tools and 22% are seeking to enhance the transparency and risk reporting of underlying funds.
In addition, managers should be prepared to offer fee concessions. Some 23 per cent of European institutional investors expected to negotiate higher management or performance fee discounts for their hedge fund investments in 2019, according to Cerulli research.
