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FundsPlaceApril 2022 Updated
The alternative investment space in Europe is undergoing drastic changes - at the product level, the investor level and the operational level. The tectonic plates are shifting, and market participants are having to rapidly evolve their businesses. At a roundtable discussion hosted by CDB FundsPlace in Dublin, leading participants in the Irish and European alternative investment sector discussed these trends and the challenges they present.
The most obvious change to the sector in recent years has been on the demand side of the equation. Asset allocators have shown a clear preference for private market strategies over public market strategies. This means demand for private equity and private debt funds is far greater than for hedge funds. There is also strong investor appetite for real asset investments, including infrastructure and real estate.
According to Jorge Fernandez Revilla, Partner at KPMG Ireland, there is strong demand for liquid alternatives, real assets and credit products. “Direct lending is huge now and we see demand across the whole spectrum of the credit curve,” he said. In contrast, Revilla says, demand for hedge funds is more muted. “Some hedge fund managers are fighting a battle to stay in business.”
This shift in product demand is reflected in the volume of work undertaken by advisers to the managers. “In the last two to three years, we have seen a real shift from unregulated funds to regulated funds,” said Philip Dempsey, Country Head of Ireland, SANNE Group. “The regulators definitely want more oversight of what is going on.” According to Declan O'Sullivan, Partner, at Dechert, “the trends are transparent in that we have seen a shift in our work from hedge funds to private equity and private debt.”
Others at the roundtable – which was moderated by Lauren Hurson, Alternative Funds Product Manager, CDB FundsPlace – cautioned that it is too early to extrapolate the demise of the hedge fund sector from these recent trends. “Good hedge fund managers have to be several steps ahead of the market for their strategies to work but, in recent years, many things that weren’t predicted to happen – Brexit, trade wars etc. – have happened and twinned with a lack of sustained volatility, the environment has been challenging,” said Harvey Colborne, Sales Director at SEI. “But as things settle down, I believe you will see hedge funds return to prominence.”
While the demand for product has changed, the requirement for stringent due diligence has not abated in any way. This gives some advantages in the current environment to multi asset products. “You have to look at the distribution channels for alternative investments,” said Revilla. “From a European perspective, the big allocators are private banks and family offices. Therefore, products need to be multi-asset because due diligence requirements are so large at the moment that the number of managers in whom they can invest is limited.”
These changes in product appetite are driven in part by the changing nature of the end investors. In Europe, the main distribution channel for alternative investments is still private banks and family offices. But insurance companies – especially those who offer life insurance and pensions – are becoming increasingly more important.
“The biggest drivers of alternative investments at the moment are pensions,” said Regvilla. “Life companies in particular are under huge pressure and many do not know how they will fund their liabilities. They are all looking for a source of income that is stable over the course of the cycle. That is why private debt and real assets in particular are so attractive.”
According to O’Sullivan at Dechert, further impetus comes from new regulations within the insurance industry. In particular, the new Solvency II rules are pushing insurance companies further into alternative investments. “Insurance companies are all looking for Solvency II solutions for alternative investments, which are almost limitless in scope,” he said.
These shifts in the product suite and the investor composition are, in turn, creating deep challenges to the operational side of alternative investments. One example of these challenges is domicile. All participants at the roundtable agreed that at present, Luxembourg seems best placed to capture this new wave of business. However, Ireland has a chance this year to really stake a claim, with the potential passage of Updated investment limited partnership legislation and bring changes to real asset investing structures. Consensus at the event is that Ireland will be in a position to win more private fund business if it brings in these new regulations. Many of these funds are already serviced in Ireland, while being domiciled elsewhere. The new regulations will allow domiciliation and servicing to be all done in the same place.
The product and investor changes mean that everyone in the market - from managers, to allocators, to asset owners and their advisors - now have to leave their comfort zones. “There are some great active managers. However, the challenge for allocators is finding those active managers that outperform passive. Recent empirical evidence suggests they can be hard to find, akin to a needle in a haystack,” said one member of the audience. “And rather than trying to find the needle, many are allocating to the haystack.” added Dempsey at SANNE Group.
As a result of this, Dempsey sees that there is a lot of committed capital to the same asset classes and deals. “Managers are therefore having to look at doing deals in less developed markets, such as African infrastructure or Indian real estate. Allocators will need to start getting comfortable with these kinds of deals and structures because that is where the growth is coming from.”
These types of products, especially the real asset investments, have to be sold face to face. This presents another challenge to an industry that as a whole is trying to move to an automated platform sales process. Combined with the issues of capacity constraint of due diligence that allocators have to address, the scope for scalability is a challenge.
The trends and challenges are fairly transparent, but what is not is how the industry responds. With so much money now chasing the same assets, it is vital that market participants embrace change. This includes investors buying new products, in new asset classes, via new structures, in jurisdictions they may not be familiar with. Done well, it will usher in a new era for alternative investments in Europe.
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