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US alt managers risk catching energy before it bottoms, says Fitch

Several top US alternative investment managers are poised to boost investments in energy and natural resources sectors, according to Fitch Ratings.

However, given the uncertainty about how long downward pressure will remain on energy and commodity prices, there is the potential that Fitch-rated alternative investment managers may overextend into energy and natural resource risks at the wrong time. While the direct investment risk would be largely borne by fund investors, alternative managers that have material missteps could experience reduced fee generation, impaired balance sheet co-investment and reputational damage. As a result, future fundraising may be affected.
The collapse of commodity prices has resulted in the most significant drop in energy and natural resource firm valuations since 2009. Consequently, there will be a point in the cycle that presents attractive, risk-adjusted, investment opportunities for lenders and investors. The unknown is the timing of this entry point. Alternative investment managers appear well positioned given their long investment horizons which generally provide ample time to wait out market volatility in order to meet target returns. But, this structural benefit can't overcome investments that are materially overpriced or poorly timed, particularly if vintage and/or energy subsector concentrations are elevated.
Alternative investment capital ready to invest in energy and natural resource sectors has risen materially in 2015. According to Preqin, approximately USD32 billion of capital had been raised for natural resources funds, year to date to 26 August, 2015. The amount already exceeds the 2013 record, when USD30 billion was raised. The average fund size of USD2.2 billion far surpasses the approximately USD700 million raised per fund in 2013 and the prior peak of USD1.5 billion per fund in 2009. While energy-focused managers top the league tables for capital raised, the large diversified managers have also increased their focus on energy investing.
Fitch believes these numbers understate the total investment capacity for the sector, as many of the largest managers' buyout funds invest alongside natural resources funds in energy deals or on their own. For example, in November 2012, Blackstone invested USD1.2 billion in LLOG Exploration Company. The capital was committed from Blackstone Capital Partners VI and Blackstone Energy Partners. Conversely, in August 2014, Blackstone made an investment in Siccar Point Energy, with the investment capital coming solely from Blackstone Capital Partners VI.
Alternative investment managers have a mixed track record in the natural resources space. According to Preqin, the median IRR on natural resources funds (USD140 billion), with a vintage 2002-2012, is 7 per cent with a standard deviation of net IRR of 17 per cent. The risk measurement is in line with buyout funds, but the returns are 400 bps below. That said, limited partners often commit capital to natural resource funds not for absolute returns, but because returns are expected to be uncorrelated with equities, and investments can provide an inflation hedge. Also according to Preqin's most recent survey, about 63 per cent of institutional investors feel their natural resources fund investments have fallen short of expectations over the past 12 months.
Despite uncertainty around the performance of current and future energy investments, the outlook for the alternative investment manager industry remains stable reflecting strong franchise positions of Fitch-rated alternative managers, large, diversified investment platforms, meaningful FEBITDA generation capability and modest, albeit incrementally higher, leverage levels. Exposure to the energy sector is also a relatively modest proportion of overall assets under management.

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