Gone are the days when a long/short equity hedge fund could simply launch and raise a yard in less than 12 months. Nowadays many managers are often waiting up to three years before they reach the coveted $100 million mark. Having grown into an institutional and arguably oversized industry post-crisis, hedge funds are finding it difficult to raise and make money, mainly because they have been crowded out of all the lucrative trades.
Meanwhile, private equity is attracting capital at lightening pace, smashing all sorts of fundraising records along the way, but it masks a long-term problem, which has already afflicted hedge funds, namely a drop-off in profitable investment opportunities due to a surplus of disposable cash. With more private equity managers chasing deals, prices have inflated and returns could drop precipitously as a consequence.
Strategy diversification is therefore warranted. In the case of hedge funds, more managers are piling into illiquid assets offering decent premiums, whereas private equity is departing from its traditional LBO comfort zone. “There has certainly been strategy diversification across the entire closed-ended funds space, which includes private equity managers,” explained Joe Patellaro, managing director and head of SS&C Global Private Equity Services.
The last few years have seen private equity managers add to their organisation’s expertise to launch credit funds, mezzanine, loan origination, distressed debt, and infrastructure products. Private equity is diversifying because of client demand and it is also a means by which to mitigate risk. Should one market dry up, then a credit portfolio could be a useful counterbalance to help ensure returns are maintained.
Direct lending products have been very popular at private equity, who have jumped in on the action as banks pull back in response to Basel III capital requirements. “Direct lending funds are filling the gaps left by the banks in the mid-market SME space,” said Bhagesh Malde, global head of real assets at SS&C Technologies. With more managers pursuing unique or new strategies, it is prompting them to outsource elements of their business operations.
“Shifts in strategies by managers introduce new complexities across their businesses and in their operations. Some private equity managers are therefore considering outsourcing middle- and back-office processes to providers offering multi-asset class solutions in response. Many managers see outsourcing as a useful tool by which to reduce their operational costs, and focus their resources on delivering returns,” highlighted Patellaro.