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Jim Cass, SEI

Tomorrow’s successful fund manager will combine PE and hedge fund expertise

As popular as the alternative investments industry remains, attracting and retaining investors at a time when asset classes are converging means that managers need to constantly think about how best to differentiate themselves. 

In short, how should GPs best position themselves, such that they can attract inflows and capitalise on an industry that has, according to Preqin’s estimations, grown to USD7.7 trillion in global AUM. 

This was the backdrop to a new survey produced by SEI in partnership with Preqin, entitled: “Finding Success as Alternatives Converge”. 

The survey canvassed the opinions of nearly 200 global GPs to sharing their perspectives on the opportunities and challenges they face as existing models for structures, strategies and operations become outdated and hedge funds and PE groups move into one another’s trading arenas.

As the survey is right to point out, tomorrow’s winners are likely to be those that “select the best people and strategies from both the private equity and hedge fund worlds”. 

Private debt and Infrastructure please

From an LP demand perspective, GPs responded by suggesting that private debt (72 per cent) and infrastructure (65 per cent) are the most preferred asset classes this year. Overall, managers are expecting growing or stable demand for most alternative asset classes although only 26 per cent cited hedge funds, a sign that demand is waning slightly relative to more popular commitment-based fund structures.

Jim Cass is SVP and Managing Director for Alternatives at SEI’s Investment Manager Services. He observes that whereas nine years ago during the financial crisis, when most LPs were frustrated if GPs suspended redemptions, gated their funds or had capital lock-up provisions, today things seem to have gone full circle. 

“Capital is pouring out of monthly liquidity funds into commitment-based structures that tie up capital and fee arrangements for five to seven years and in some cases longer, and LPs aren’t blinking an eye. They are readily moving in to these kinds of structures,” says Cass.

Managers are not just buying illiquid positions in these portfolios. They are increasingly taking on hybrid liquidity characteristics. Given that LPs want to get the best returns, GPs are not only looking at long-term opportunities. They are also looking to capitalise on short-term volatility to boost returns. 

In other words, fund managers are not just playing one position on the field, they are playing multiple positions. This is on the proviso that they have the skills and attributes to evolve their product offering, without risk of diluting their core offering. They have to be seen to be asset managers, says the survey, not merely asset gatherers.

Another point that the survey highlighted was how large these funds are becoming. 

“The average private equity fund is now USD100 million larger, on average,” says Cass, rising in size from USD442 million in 2007 to USD532 million today. 

Customised strategies popular

One could argue that alternative strategies and structures have become so intertwined that it is difficult to know precisely what a private equity fund is versus a hedge fund. There is a blurring of the lines as GPs try to evolve their product offerings in such a way as to satisfy investor demand. 

To illustrate, the SEI survey found that one out of four GPs are planning to offer hedge funds with PE-like fund structures, while 49 per cent said they were looking to develop customised structures.  

Often, large institutional investors will look beyond individual asset classes and strip everything back to what the underlying market risk is. They are not looking at having, for example, 30 per cent exposure to private equity, 30 per cent to equity long/short hedge funds, 40 per cent to long-only ’40 Act funds, etc. Increasingly, they want to evaluate their allocations in terms of equity risk,  credit risk, or commodities risk, whatever the portfolio may be. The actual vehicle is a secondary consideration.

Building a bigger mousetrap

Discussing the customisation point, Cass comments that building a highly custom structure is not economically sustainable unless the GP can be confident of attracting substantial assets, i.e. the structure should be created in such a way to capture many different investor types and can accommodate multiple fee structures. 

“While managers have increasingly accommodated investors’ demand for custom products, it is not financially viable to structure something just for one mandate, and then structure something else for a second mandate and so on.  It’s better to build something scalable to support a number of investors that will hopefully come into the structure over time. 

“That way you avoid building multiple single investor mousetraps, which can become complex to operate.  It’s more efficient and sustainable to have one that can service multiple investor types. 

“That’s where some managers have failed a little bit. They chase the next mandate rather than thinking about how to scale their business strategically from the onset. They overlook how expensive and resource-draining it is support all these structures,” remarks Cass. 

In terms of how managers position themselves to maximise their competitiveness, the survey would suggest that LPs are more apt to go to a specialist fund manager (60 per cent of respondents) if they are intending to invest in a single asset class, and a broader diversified fund manager for multiple asset classes (54 per cent of respondents). 

As with most aspects of investing, this comes with a trade-off. Whilst a specialist manager brings a focus and a deep level of expertise, they might be limited in their investment opportunities. Moreover, specialist fund groups tend to be smaller in terms of AUM and as such might not offer the institutional quality infrastructure investors are seeking. 

The flip side to this is that generalists, although much larger entities with greater resources and institutional infrastructure, might not deliver the same level of asset class expertise. To caveat this point, Cass says: “An enterprise manager might have multiple specialists under the same roof who can leverage that manager’s infrastructure.

“That way, the LP gets the benefit of a specialist manager from a strategy and return generator perspective, but also benefits from the backing of an institutional manager who is able to invest more in its infrastructure.”

At the end of the day, if one looks at where the majority of inflows are going, it is still to the largest fund managers, a trend that is unlikely to change anytime soon.

More complexity = more outsourcing

Seven out of 10 managers surveyed said that they are targeting new investor segments, or had plans to do so, as a way to reinvent themselves and stay fresh in the eyes of LPs. Six out of 10 managers confirmed that they were offering, or planning to offer, new fund structures. 

Not that this is a straightforward decision. Every time a GP attracts new investors or embarks on marketing a new product, this adds to the operational challenge. Commitment-based structures haven’t caught up to current innovations and processes in terms of how they interact with LPs. It is still largely paper-based, and relatively reliant on manual processes.

“As a manager, automating a lot of that is tough to do on your own when there are often better solutions  going to a third party who has broad expertise  and done it for  many clients,” comments Jim Warren, Head of Solutions Strategy & Development at SEI’s Investment Manager Services division.  “At SEI we’ve developed a trade application that digitises subscription/redemption transfer documents that allows an LP to trade electronically and provide an electronic signature that is deemed, in most cases, to be more secure, and takes far less time, than providing a paper document.”

“I think as the industry becomes more institutionalised, GPs will want an (operational) structure to distribute their funds more effectively so that they can access more investors and capital than they could just three or four years ago,” adds Warren. “Providing an enhanced investor experience is going to be an increasingly critical part of the sales and relationship management process going forward.”  

In that regard, working with trusted outsourced partners will be paramount. Today, managers are still spending a lot of money on internal functions – 47 per cent and 44 per cent of GPs said they were planning to dedicate additional resources to investor servicing/reporting and data management respectively. 

Following Cass’s earlier comment on building a better mousetrap, in order to succeed and win new investors, fund managers will need to do so in a way that does not become operationally suffocating. 

Outsourcing is the obvious way to ease this burden, with 68 per cent of GPs confirming they were using third parties for cybersecurity and 67 per cent for fund administration. Other areas, such as data management (42 per cent) and pricing and valuation (47 per cent) are increasingly becoming key outsourced activities. 

That trend will likely continue as GPs evolve.

“We see a lot of managers creating something that is new to them by having feeders in multiple jurisdictions, having SPVs, managed accounts and so on, but they need the infrastructure to support it. In an ideal world, infrastructure should never get in the way of new product development, distribution efforts or providing new or more timely reporting.

“However, I don’t think there are enough COOs and CEOs speaking enough about the marketing side of things. Build it and they will come, is never a good idea. If you don’t have investors lined up to invest in whatever new products you are creating, you’re likely going to end up spending a lot of money on lawyers, tax consultants and other outsourced providers, and yet you may end up not attracting enough new capital to grow to the level to meet your expectations.

“As alternatives converge and GPs’ businesses become more complex, the successful managers of the future will need an integrated operational platform that allows them to support their investment expertise with a streamlined, technology-enabled investor experience.  Managers have to be smart about how they develop new products and be confident that they’re going to gather assets by doing so. 

“Clearly, investment acumen is the most crucially important reason GPs thrive, but we believe that having a robust and product-agnostic operational infrastructure will give the agility and comfort needed to satisfy both manager and investor for the long term,” concludes Cass.

To read SEI’s survey in full please, click on the following link: www.seic.com/seizechange 

 

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