Private equity the key alternative says BNY Mellon

BNY Mellon's survey shows private equity is gaining traction as an alternative investment strategy
By Editorial
Private equity is the most sought after alternative investment strategy, accounting for 37% of investors’ alternative exposure, according to a survey by BNY Mellon.

This comes as the asset class delivered strong performance with 97% of investors telling BNY Mellon that private equity had met or exceeded expectations. Private equity is currently running record Assets under Management (AuM), according to Preqin, standing at $2.4 trillion at June 2015. The BNY Mellon paper acknowledged that by year-end 2014, seven of the year’s largest buyout funds raised $5 billion each, while smaller, niche or specialist funds had also witnessed a surge in popularity. Fifty-three per-cent of allocators confirmed they would increase their private equity exposure over the next 12 months, added the BNY Mellon paper.

“It is clear from our research that institutional investors are either looking for absolute returns, diversification and non-correlated returns. Private equity has been one of the best performing alternative asset classes over the last few years,” said Mark Mannion, head of EMEA relationship management for Alternative Investment Services at BNY Mellon, speaking at Fund Forum International 2016 in Berlin.

Despite the strong fundraising environment, private equity is facing some pressure, particularly around fees. Sixty-two per-cent of respondents to the BNY Mellon study they were looking to lower private equity fees over the next 12 months. Fees have been a contentious issue of late with investors complaining about the fee structures and expenses charged by their private equity managers. Californian pension fund CALPERS recently demanded greater transparency from private equity managers about their performance fees while a handful of US state legislatures are looking to introduce rules forcing fund managers to disclose their fee structures to external investors such as state pension funds.

“Fees are an increasingly important issue for institutional investors as they want value for money. Investors only want to pay for good performance, and there is a push from some investors to make fees more palatable than the traditional 2% and 20% model,” said Mannion.

National regulators including the Securities and Exchange Commission (SEC) have also criticised the lack of transparency and potential conflicts of interest that can arise in private equity fee structures. A much cited speech by Andrew Bowden, former director of the OCIE (Office of Compliance Inspections and Examinations) at the SEC said expense allocations and law violations around fees at private equity were endemic. It was inevitable that high-profile settlements would follow suit. Major private equity houses including KKR and Blackstone have settled with the US regulator over misaligned interests around fees.

In terms of other alternative strategies, infrastructure and real estate are the second and third most popular among investors. However, hedge funds account for just 14% of institutional investor allocations. Forty-five per-cent told BNY Mellon that they did not have any money invested in hedge funds. Hedge funds have incurred bad press of late with several major institutions criticising their disappointing performance relative to their high fee structure.  Indeed, CALPERS and Dutch pension fund PFZW have both confirmed they will no longer include hedge funds in their portfolios.

“A handful of high-profile US pension funds have publicly dropped hedge funds from their portfolios, but overall these are the exception rather than the rule. Most investors are sticking with alternatives, and increasingly deploying managed account or liquid alternative structures,” said Mannion.

Interestingly, the BNY Mellon study found 94% of investors are satisfied or very satisfied with their hedge funds. Nonetheless, the study concede that hedge funds have struggled to recover following the financial crisis. “To overcome this relative reticence, the hedge fund industry is developing a range of solutions to make it easier and cheaper for institutional investors to access the strategies that they offer,” read the BNY Mellon paper. 

Nonetheless, a sizeable portion of investors do see hedge funds as useful risk diversifiers away from stocks and bonds, particularly when markets are volatile. “Most investors are adopting a long term approach towards their alternative investments. While some hedge fund strategies underperformed last year, most investors are happy with their long term performance and that is encouraging,” said Mannion.

The BNY Mellon paper acknowledged that liquid alternatives were growing as hedge funds convert their strategies into UCITS or ’40 Act products giving them access to retail money. Data from Cerulli Associates indicates liquid alternatives are the fastest growing segments in the fund market, and could run 14% of industry assets by 2023. Others, however, are not so sure and feel that liquid alternatives may be running out of stream amid disappointing performance. They have also faced pressure from far cheaper index tracking funds.

“Adopting a UCITS or 40 Act structure at hedge funds subjects managers to increased liquidity, transparency and governance requirements. The guaranteed liquidity in liquid alternatives does appeal to institutional investors. Equally important is the transparency. Nonetheless, investment and leverage restrictions do mean that performance returns may be slightly lower than an unconstrained hedge fund,” highlighted Mannion.