Investors are increasingly looking to alternatives that don’t compromise on liquidity and transparency, but at what cost? Emma Cusworth reports.
“You get more alpha if you are willing to give up some liquidity. It’s very real and you cannot get around it, but that doesn’t mean you should be overpaying.”
Laurence Wormold
Liquid alternatives are one of the fastest growing segments of the asset management industry. The growth of this sector, which includes alternative mutual funds and UCITS hedge funds, has been driven by a better understanding of alternative assets by investors and their unrelenting focus on costs and risks.
A study by Deutsche Bank showed demand for hedge fund liquid alternatives has grown significantly, with the number of respondents allocating to these products up from 28% to 51% year on year. The numbers show this is now the fastest growing segment of the asset management industry, having grown over 40% annually since 2008. The hedge fund and wider European UCITS industries, by comparison, have increased only 13% and 2% respectively. Deutsche expects net inflows from survey participants to grow by 44% over the 12 months to September 2015, which equates to $49bn.
Research by Preqin, meanwhile, showed the growing appetite for these products was being driven by institutional investors’ demand for greater liquidity and transparency. Their data showed 53% of investors they surveyed ranked the greater liquidity offered by these products as the reason for investing in liquid alternatives, followed by increased transparency (31%), increased regulation (28%) and lower cost (19%).
According to Mark Mannion, head of business development and relationship management EMEA for alternative investment services at BNY Mellon, demand for this product area was initially driven as a consequence of the financial crisis, during which institutions felt there was a lack of liquidity and transparency in the classic hedge fund structure.
“Institutions have driven a lot of the demand for new products established since 2008,” he says. “Many are no longer as comfortable investing in offshore structures. This has created a niche for alternative UCITS, which comes with the promise of transparency and the comfort of regulated liquidity.”
GIVING UP THE ILLIQUIDITY PREMIUM?
The debate about how much liquidity institutional investors, particularly pension funds, really need to take continues unabated. Investors are constantly told to exploit their long investment horizons to benefit from the illiquidity premium. The foundations of the widely adopted endowment model of investment are based on this principle.
The reason for institutions placing such an emphasis on liquidity in their alternative allocations might appear to be a reaction to a short-term issue: investors became more riskaverse in the wake of the financial crisis, placing a premium on liquidity.
“One big topic drives growth of liquid alternatives,” according to Jan Viebig, CEO of Harcourt. “Post-2008 institutional and retail clients said they didn’t want hedge funds in their old form. They want liquidity. They don’t need it daily, but they hate gates and lock-ups as they can’t redeem when they want to.”
But there is a price for that liquidity.
Viebig admits: “It is extremely important for the industry to tell clients that returns of certain liquid alternative strategies will be more moderate versus traditional hedge funds as they cannot take as much leverage or illiquidity.”
The focus on greater liquidity driving liquid alternatives is partly a result of investors’ painful experiences during the 2008 financial crisis, but it is also fuelled by a bigger picture. Institutions are increasingly knowledgeable about hedge funds as their experience grows, which allows them to achieve significant efficiency gains.
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