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Alternative Investment Management Association Representing the global hedge fund industry

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The retail alternatives phenomenon

Ross Ellis, Vice President and Managing Director, Knowledge Partnership, Investment Manager Services

SEI

Q3 2013

 

It is no overstatement to say that the move toward investing in alternatives has been one of the farthest-reaching developments in institutional investing over the last quarter century. The past decade has seen two waves of particularly rapid growth. Between 2005 and 2007, global alternative asset classes managed by various types of managers nearly doubled, from $2.9 trillion to $5.7 trillion.

After a pause in 2008, as shocked investors regained their bearings and took stock, the importance of non-correlation and hedging truly hit home. Global alternative assets under management then rose to a record level of $6.5 trillion by the end of 2011, with a growth rate far outpacing that of traditional asset classes during this period.

Now a third wave of growth in alternative investing is underway, only this time it is encompassing the mainstream. Alternatives are migrating from institutional to retail markets, just as the use of asset allocation models did several decades back.

 

The retail alternatives market

The market for retail alternatives is huge and growing yet still in its infancy, offering exciting long-term opportunities for private fund managers who seek to diversify their revenue streams and find new outlets for their capabilities. The migration of alternatives into the retail space comes at a propitious time for private fund managers. While institutional investors have spearheaded the growth of alternatives and continue to increase their allocations, the industry is maturing, suggesting that allocations may not grow as rapidly in the future as they have in the past. Casey Quirk’s recent study, The Complete Firm, is bullish on the retail market, predicting that individual investors will drive the demand for alternative strategies. The firm predicts that AUM in those strategies will grow at a compound annual rate of 10.2% amongst mass affluent investors and 9.3% in the high-net-worth segment, as opposed to 7.7% for institutions

Based on the recent growth of hedge-style mutual funds, the blend of alternative strategies with the transparency, liquidity and regulatory oversight of regulated retail investment vehicles has growing appeal to financial advisors and their clients. Even in the defined contribution retirement plan market, which has tended to skew conservative, non-traditional investments, such as real estate investment trusts, are gaining traction, paving the way for an array of alternative strategies.

For private fund managers, this is a sea change that could open up a whole new area of opportunity —

indeed, one that could potentially dwarf the institutional market. Yet, to those steeped in the rarefied world of hedge funds and private equity, the retail landscape is like a foreign country — one that is distinctly different in terms of its culture, product development, marketing and distribution, regulatory framework and operational environment, not to mention fee structures.

 

Key findings

This trend presents private fund managers with a vast new market at a time when the growth of institutional allocations to alternatives may be slowing. In addition to its size and growing momentum, the retail market offers private fund managers the chance to diversify their revenue streams, earn more consistent fees, and market their capabilities with fewer restrictions.

 

  • Retail alternatives — that is, investment strategies traditionally utilised by private hedge and private equity funds packaged for individuals, generally as mutual funds or UCITS — are a rapidly emerging sector of the asset management industry.
  • Industry analysts, such as McKinsey & Company, predict that alternatives’ share of the U.S. mutual fund market will double from 2010 to 2015, and they are expected to account for nearly one-fourth of all retail revenue by the end of that period.
  • From just €5.4 billion at the start of 2002, the AUM of alternative UCITS grew to €37.6 billion as of January 2009, mushrooming to nearly €150 billion as of October 2011, according to PerTrac. With all UCITS funds adding up to €5.63 trillion at year-end 2011, alternative UCITS account for a small but growing percentage.
  • While the DC market historically has been out of reach to alternatives, plan sponsors have begun investing in real estate, inflation-protected government bonds and commodities in search of greater yield potential. As such, retirement plans, especially DC plans, may be the most attractive target for private fund managers. They are also a logical point of entry to the retail market, in that managers can market through professional plan consultants and platform gatekeepers rather than directly to individuals, allowing for economies of scale and more efficient routes for investor education.
  • Multi-asset strategies that provide one-stop allocation solutions are gaining traction. Alternatives are also entering the DC market through asset allocation products, such as target-date funds. Alternative managers may participate either by managing sleeves within asset allocation portfolios or by introducing stand-alone products
  • For private fund managers, however, moving into the retail market will be no easy matter. Beyond dealing with cultural and regulatory differences, they will need to develop specialised distribution expertise and infrastructure, commit substantial resources to education, and be willing to wait for profitability.
  • Before launching a retail alternative product, managers must thoughtfully consider a number of decisions, including the suitability of the investment strategy, the best vehicle for retail packaging, whether to be a direct sponsor or sub-advisor of the fund, whether to launch a stand-alone fund or join in a shared trust structure and pricing.
  • The distribution of retail alternatives is complex, involving a maze of sales channels, specialised consultants and intermediary platforms. To be successful, managers will need to develop marketing strategies, understand platform requirements, maintain specialised sales teams and populate key industry databases, amongst other steps.

Realistic view of the opportunity

It is vital that entrepreneurial fund managers take a balanced and realistic view of the opportunity in retail alternatives. Capitalising on its potential is no easy matter. Private fund managers who want to succeed will need to overcome a number of obstacles, devote substantial time and resources to educational efforts and find ways to fill their gaps in fund infrastructure and distribution expertise. They must also be willing to make investments, both in the substantial start-up process and ongoing, as fund operations may need to be subsidised for some indefinite period of time; profitability will not come overnight.

Of course, opportunities remain in the institutional market Institutions continue to incrementally increase their alternative allocations, and undoubtedly some hedge fund and private equity managers will want to remain institutionally-focussed. But for those who are willing to take a long-term strategic view, desire a new investor base with different revenue sources or want to be evangelists for their investment processes, retail alternatives may be too important and promising a trend to ignore.

 

rellis@seic.com

www.seic.com/alternativeretail

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