Investors diversify alternative assets exposure in 2017

April 2017 | EXPERT BRIEFING | FINANCE & INVESTMENT

financierworldwide.com

The alternative assets industry is bigger than ever, with more than $7.7 trillion in hedge fund and private capital assets managed globally. The industry has cemented itself as an important facet of the investment portfolios of large institutional investors – pension funds, insurance companies and foundations – and our latest survey shows that they are becoming more sophisticated and diverse in their alternative asset allocations.

We surveyed over 500 institutional investors in December 2016, to gauge their sentiments toward the alternatives industry, and to find out their aims and concerns in 2017. Perhaps the most striking thing is the level to which these institutions are now involved in the industry: four out of five have an allocation to at least one alternative asset class, a continuation of the gradual increase of engagement seen over recent years.

Beyond that, the number of institutions allocating to most or all of the alternative asset classes we track has risen more significantly. At the start of 2017, over a third of investors allocated to four or more separate asset classes, up from a quarter that did so a year ago. Of these, a fifth allocated to five or more asset classes, and almost one in 10 has invested across the entire alternatives spectrum. Both of these proportions are almost twice the level seen 12 months prior, which is indicative of the level of engagement within the industry now prevalent among investors.

A key part of this appeal is the opportunity for returns that alternative assets offer, and their ability to aid investors in achieving often demanding returns thresholds. Over the three years to the end of June 2016 (the latest data available), private equity (16.4 percent), venture capital (16.7 percent) and real estate (14.9 percent) funds have all delivered an annualised return greater than the S&P 500 (13.1 percent). This outperformance helps to make the industry attractive to investors, which have generally retained a high appetite for alternatives investments in recent years.

Due to this high performance, closed-end private capital funds (private equity, private debt, real estate, infrastructure and natural resources) have returned historic levels of capital to their investors. In H1 2016 alone, private equity funds globally returned $257bn to their investors, while real estate funds distributed $128bn and infrastructure funds distributed $30bn.

Unsurprisingly, these unprecedented distributions have contributed to the high levels of satisfaction in the industry – at least four out of five investors in each private capital asset class now have a positive or neutral perception of the industry. Among private equity investors, 84 percent have a positive view of the asset class, compared to just 3 percent that hold a negative opinion, and this trend is replicated across asset classes.

These factors may partially explain the robust fundraising that most of these asset classes saw in 2016. Across the private capital spectrum, funds closed in 2016 raised a combined $634bn, following the $600bn raised by funds closed in 2015. This fundraising period, then, is second only to 2007-2008 for alternatives fundraising, and it is unsurprising that private equity, infrastructure, real estate and private debt all saw notable fundraising totals.

Fundraising has been aided by investors seeking to reinvest capital that has been distributed to them, partly by investors seeking to reach target allocations which are trending higher, and partly by investors diversifying their alternatives allocations in order to gain more exposure to the industry. It has resulted in a huge influx of capital becoming available to managers, and consequently dry powder rates across the industry are breaking successive historic highs.

The deal making market has witnessed the consequences of all-time high dry powder levels, as managers are able to compete more for deal opportunities, and offer higher prices for assets. Many managers across asset classes report that competition for deals is higher than it was a year ago, and asset pricing is a key concern for firms in the year ahead. This concern has fed back to investors: in four out of five private capital asset classes, valuations are cited as the primary concern in 2017.

There is also a sentiment among investors that this pressure will ultimately impact performance over the next 12 months, and that private capital may not be able to maintain the same high level of returns that it has enjoyed in recent years. Notably, among investors in private equity, real estate and infrastructure, a larger proportion expect these asset classes to perform worse in 2017 than they did in 2016. This is not to say that investors expect performance to suffer, but rather reflects the difficulty of maintaining recent returns in a high-price environment.

Investors’ reactions to this set of circumstances have fluctuated across different asset classes. In private equity, private debt and unlisted infrastructure, a greater proportion of investors indicated they were planning on investing more capital in 2017 than said they would decrease their commitments. Investors in private real estate and natural resources, however, are more mixed in their reaction: roughly equal proportions intend to increase their commitments as will look to decrease them.

Over the longer term, though, investors are very positive about their intentions toward their alternative assets allocations. The vast majority of investors in each private capital asset class said that they either intended to increase or maintain their allocations over the longer term. In particular, 62 percent of private debt investors and 53 percent of infrastructure investors said that they wanted to increase their long-term allocations, reflecting the potential for future growth in these industries. Even in the natural resources fund management sector, which has seen continued difficulties deriving from the broader challenges facing the industry, more than three out of four investors said that they would hold or increase their current allocation levels.

Overall, then, the alternative assets industry faces a challenging 2017. Managers will have to compete in order to find and secure the most attractive deal opportunities, and high valuations for many assets are likely to be a focal point for the industry. However, over the longer term, investors clearly remain very committed to the industry, and hold it in high regard. While some may be planning to limit their commitments over the next 12 months, the majority intend to maintain or expand their alternative assets programmes, and the industry as a whole may well see continued inflows and further growth.

Andrew Moylan is head of real estate products at Preqin. He can be contacted on +44 (0)20 3207 0330 or by email: amoylan@preqin.com.

Andrew Moylan

Preqin