Following on from the GP survey it produced earlier this year, SEI once again partnered with Preqin, this time to garner the views of investors to understand how they approaching alternative asset investing.
Several key findings emerge. Not only are investors looking at specialist firms versus diversified firms, LPs still want better transparency on the fees they are paying, and where those fees are going.
“I see that particular trend only growing. When you’re investing with a particular GP, and they are collecting fees, it’s only reasonable investors are interested in understanding what fees are directed towards boosting the return versus what are being used to improve the margin of the GP, comments Jim Cass (pictured), SVP and Managing Director for Alternatives at SEI’s Investment Manager Services.
Another key finding is the broad portfolio allocation to alternatives that LPs have. Private equity can be found in the portfolios of 95 per cent of investors surveyed while real estate investments can be found in 83 per cent of portfolios. Such has been the rise in popularity of private debt that 69 per cent of LPs said they had exposure to the asset class, only just behind hedge funds (71 per cent), which while still relevant, have slightly lost their lustre the last couple of years.
When there is a widespread bull market in equities and you’re investing in hedge funds and paying much higher fees than index or tracker funds, investment committees might well question the strategic rationale and opportunity cost.
The benefit of many hedge funds is to deliver a total return, regardless of what the markets are doing; but that becomes a harder sell when they underperform major stock market indices, which is where a lack of understanding still exists. People don’t understand that most hedge funds aren’t designed to outperform in a bull market.
“Some managers are rooting against the bull market and want more volatility so they can show their true value again; and this year has certainly been a better year, performance-wise for hedge funds, but not at the level we’ve seen in the long only equity markets.
“There are too many managers chasing the same ideas. I think what we are starting to see is a thinning of the herd. Like any business cycle, it has to recalibrate itself before it can grow back out of it. I don’t think it’s a long-term trend, rather it’s a reflection of just how saturated the hedge fund market is at the moment,” says Cass.
As a proxy for where investors are thinking about allocations over the next 12 months, infrastructure and private debt in particular are expected to rise, with 53 per cent and 46 per cent of investors surveyed saying they will increase allocations to these asset classes respectively.
Somewhat revealing is the fact that 49 per cent of LPs said they planned on reducing their exposure to hedge funds, with only one in five confirming they would increase their exposure to the asset class. While many investors still believe in what hedge funds can offer, there has increasingly been a focus on the value derived from those investments versus fee paid, and thus a search for alpha elsewhere.
On the transparency issue, there is clearly still a significant disconnect between GPs and LPs.
The survey finds that only 25 per cent of investors are pleased with existing levels of transparency surrounding operating expenses, compared to 67 per cent of GPs in SEI’s earlier survey, who feel the level of transparency they offer is sufficient.
This disconnect is significant; especially given that it was the most important consideration when evaluating managers, as cited by 54 per cent of LPs.
“GPs across the board feel like they are dealing with the transparency and reporting issue, but on the LP side, opinions vary. They are broadly aligned with respect to portfolio companies/assets – the figures are 71 per cent and 81 per cent for LPs and GPs respectively - but LPs don’t want to just be aligned with an asset that is simply called an SPV; they want to see what’s inside. They want to know from where they are getting returns at the most granular level possible,” comments Cass.
What’s interesting is a lot more LPs are going into lock-ups or commitment-based funds so even if they do get good reporting from GPs, whilst it might be good to know what’s happening in the portfolio, there’s not a whole lot LPs can do anyway. It’s not like they can exit the fund if they don’t like what they see.
“It gives them a better feel for risk, how the fund fits into their overall portfolio, and what their next investment ought to be; that’s why they want the extra level of detail, but they are really hamstrung. Even when they get the extra level of transparency, how empowered are they to do anything about it?” questions Cass.
Still, in his view it behooves GPs to provide good reporting. A knowledgeable, more informed investor is a better client, but also once they have been provided enhanced reporting, it is more likely that they may receive additional mandates from them in the future as the managers seek to roll out new funds.
“GPs know they should always try to meet the demands of their LPs because they are the lifeblood of your business. Good returns will always attract investors but you have to also think about the more intangible, or non-portfolio specific things, the value-adds as it were. And as the market has evolved, really good, insightful reporting is certainly one of them,” adds Cass.
One way to address the transparency disconnect is to allow LPs to data mine on their own, which could help close the gap.
“Instead of just doing canned reports that you think services the majority of your LP base, why not open up a platform or a dashboard capability that allows the LP to customise the data they want, when they want, from your enriched fund data?
“That’s exactly what we are building here at SEI. We’ve had the Manager Dashboard and Investor Dashboard in place for a while now, and we now have an SEI Trade platform, which is designed to help make it easier, quicker and safer for LPs to subscribe/redeem with managers.
“Many GPs are still taking a one-size-fits-all approach to reporting. The most sophisticated managers are figuring out how to get a data model in place that services 100 per cent of their LPs’ needs, rather than just the majority of their LPs’ needs. Put the power in the LPs’ hands and make the reporting experience more customisable, dynamic and enjoyable,” recommends Cass.
When thinking about the size of fund, before investing, the survey finds that private equity and private debt are regarded by LPs as being the most negatively affected by fund AUM.
Almost one out of three investors say that the ideal private equity fund size should be smaller than USD1 billion, with almost half of this group saying the ideal fund has less than USD100 million of assets. In contrast, infrastructure funds are least often seen as being negatively affected by fund size; 64 per cent said the fund level did not matter, overall.
“To me it’s about dilution,” remarks Cass, in relation to the private debt and private equity figure.
“There’s a general thought that the survey points to in that the better ideas are the newer ideas, and they tend to be microscopic, or more concentrated into a specific strategy, or transaction even. While there are some enormous funds that offer exceptional returns, the survey is telling us that LPs have to spend more time mining for the right opportunity rather than just following the herd.”