For over a decade now, the continued trend of convergence between long only funds and alternative structures such as hedge funds, private equity and real estate funds has been gaining momentum. This convergence is now front and centre for fund managers as well as service providers, perpetuated by the changing expectations of institutional and retail investors combined with evolving regulation.
For example ten years ago, according to a 2004 study by Casey Quirk and BNY Mellon, the alternative investor base was overwhelmingly dominated by High Net Worth (HNW) individuals or family offices, accounting for over 98% of hedge fund capital flows that year, whereas institutional investors were largely focused on the mutual funds industry, as illustrated below.
The last decade however has seen institutional investors such as Sovereign Wealth Funds (SWF), pension funds and insurance companies increasing their allocation to alternatives; increasingly looking for diversified exposure and better returns in the low interest rate environment. Similarly retail investors are increasingly looking for better, more diversified or market independent returns from their mutual funds resulting in a growth in absolute return funds. These two investor type drivers have caused the characteristics of mutual and alternatives to extensively overlap as the markets converge.
The long only world has been well regulated by established vehicles such as UCITS in Europe and 40Act in the US. To cater for the expanding convergence, Europe granted UCITS greater freedom to follow alternative strategies, giving rise to so called NEWCITS or alternative UCITS structures.
In addition, the gathering forces of convergence have been accelerated by new regulations such as the Dodd-Frank Act in the US and AIFMD in Europe, both introduced in response to the financial crash and subsequent drive to regulate the alternatives industry and better protect investors. So today the industry has converged further, as illustrated below:
This accelerating convergence has resulted in alternative funds becoming more ‘traditional’ in nature with daily liquidity, higher numbers of investors, higher trading volumes and distribution networks and associated commissions. Conversely, long only funds have now developed alternative characteristics such as complex instruments like derivatives and OTCs, as well as performance fees, equalization, complex master feeder structures, and side pockets.
The key challenge now for managers and service providers alike is to cater for this growing convergence in a highly efficient and consistent manner based on common processes and systems; thereby returning maximum value and return to investors whatever their flavour of investment. In 2020, mutual, hedge, private equity and real estate will likely simply be known as the funds industry without the differentiation we have now.
Keith Hale, Multifonds
ALFI TASC member
Breakout session: Focus on Alternatives – the long road to Alternatives