Traditional And Alternative Investment Strategies Converging
Traditional “long-only” and alternative investment strategies are converging as alternative investments (such as hedge funds, private equity, real estate and structured instruments) have gained in popularity and influence. That is one of the conclusions of the sixth in an annual series of research reports produced jointly by KPMG International and CREATE-Research. The comprehensive 60-page report is based on input from over 200 investment managers, both long-only and alternative, including pension funds.
Convergence is occurring as managers have diversified into new strategies that are outside their normal sphere of expertise. According to the report there are three principal convergence trends:
- Between long-only and alternative investments; long-only managers adopting alternative techniques and vice-versa
- Between alternative investments – ‘product widening’. For example, private equity managers adopting hedge fund techniques and vice-versa
- Within asset classes – ‘product deepening’. For example, a UK real estate fund expanding its portfolio into Europe.
Convergence is neither universal nor unequivocal: within each sector, managers have fallen into three groups: purists, who have stuck to their core capabilities; pragmatists, who have diversified; and procrastinators, who have considered change without actions.
Managers want to run exciting products…while investors want something they can understand that delivers good results. Real estate, infrastructure and private equity are most favored by investors. This mismatch needs to be addressed.
Other findings of the report:
- Convergence between managers, the increasing complexity of financial instruments and a changing investor base are likely to drive up the demand for risk specialists who can stress test portfolios, do independent valuation and enhance overall transparency.
- The recent credit crisis will spark flight to quality favoring a new wave of customized structured finance products with principal protection and transparency as the main features.
- As a knock-on effect, third party administrators will grow rapidly by developing new skills and capabilities for new asset classes, driven in part by the institutionalization of alternative investments.
- The private equity industry will no longer be so private as governments and investors continue to demand more transparency, independent administration and new fee arrangements.
- Many hedge funds are absorbing the shock of the recent credit crisis through their contrarian strategies.
- Performance related fees are likely to become ever more popular as pension funds continue to force different fee structures for alpha and beta products.
- The demand for talent is outstripping supply in all corners of the market. This is likely to create retention difficulties and an increased inflationary pressure in the industry.
- The recent credit crisis is likely to slow down the pace of convergence between long-only and alternative investments as it takes its toll on managers in all sectors but it won’t reverse the thrust.
- The pace of convergence in future will rest on managers’ ability to deliver attractive returns, while ensuring that the nuts and bolts of operations are tight.
- Growth expectations for the next three years have fallen to average single digits for all asset classes in long-only and alternative investments.
- The investment industry will continue to consolidate with M&A activity occurring within and across all segments of the sector as organizational convergence mirrors product convergence.
The report Convergence and divergence: New forces shaping the investment universe is available for free download.
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