AIMA/PwC: Distribution Disrupted - Spotlight on alternatives
By AIMA/ PwC
Published: 14 December 2015
The following is an online summary of this particular AIMA paper
The rapid changes across the global economic landscape due to the financial crisis have generated tremendous change in the asset management industry as it has assumed centre stage. The need for increased and sustainable long-term investment returns has increased investor appetite for alternative asset classes in particular.
The alternatives industry, having slowly begun the process of institutionalisation prior to the crisis, is now maturing more rapidly in order to manage a variety of distribution opportunities, which is a priority for firms continuing to seek growth. More traditional distribution approaches, significantly, have been disrupted by regulation and by a more vocal and influential investor base.
This report, a collaboration between PwC and the Alternative Investment Management Association (AIMA), examines this disruption of distribution trends in the hedge fund sector and explores how firms are dealing with and driving the resulting challenges and opportunities.
The report is based on a survey in mid-2015 of 146 AIMA members which manage traditional hedge funds, or liquid alternative funds, or both. The respondents to the survey manage around $550 billion in hedge fund assets (1), or close to 20% of the global industry, which manages around US$2.9 trillion in assets. (2)
The survey population includes leading hedge fund firms in Europe, North America and Asia, many with extensive distribution networks (see Survey Demographics section, below). More than half of the firms surveyed manage more than US$1bn in Assets Under Management (AuM), and a quarter over US$10bn. In North America and the UK, more than a third of firms surveyed had AuM of over US$10bn.
PwC also interviewed managers at a number of these firms on a one-to-one basis to delve into greater detail on their distribution approaches and the opportunities and challenges they encounter in the marketplace. Their comments and insights are reflected in the report. It is clear that most firms are aware of the changing landscape and the growing opportunity, and are now actively developing and refining their distribution strategies accordingly.
The report is accompanied by ‘Viewpoints’, which seek to analyse the report’s findings and project the implications of those findings into the future. In this sense, the report is aligned with PwC’s Asset Management 2020 and Alternative Asset Management 2020 reports (3), which forecast the shape and needs of the asset management industry in the coming years.
We hope you find the report insightful and helpful.
EMEA Alternatives Leader
Regulation sparks distribution awareness. A rapidly evolving regulatory environment has focused minds in the hedge fund industry. Systematically identifying and targeting sales channels and targets used to be an opportunistic rather than strategic activity at many hedge funds. But in the wake of new regulation, many firms are developing sophisticated processes to decide which investor channel or channels, and which markets to target and, consequently, which regulatory regimes they are prepared to address.
Regulation is opening up the opportunities for hedge funds distributing in Europe, the US and Asia. For example, the Chinese currency is slowly opening up to internationalisation and Beijing is reducing investment barriers. Such changes bring investment opportunities. Even the EU’s Alternative Investment Fund Managers Directive (AIFMD) represents an opportunity for firms which may wish to avail themselves of some of the private placement regimes in more liberal Member States, or choose to fully comply and thereby gain a passport to sell funds across the EU.
AIFMD has changed the distribution game for hedge funds. It has been a catalyst for firms to reconsider their distribution strategies – more than three-quarters of managers in the survey say they have changed where or how they market non-EU Alternative Investment Funds (AIFs) to EU investors in the wake of AIFMD. If the AIFMD passport is extended to allow EU Alternative Investment Fund Managers (AIFMs) to market non-EU AIFs to professional investors across the EU, many EU AIFMs say they would apply for a passport. In the meantime, a good number of non-EU fund managers that are marketing in the EU have decided to create their own EU AIFMs or become sub-advisers for EU AIFMs instead of opting to use a non-EU AIFM.
It is clear that scale provides cost advantages that enable investment in meeting regulatory requirements, and this deepens the divide between the large and small managers. Larger managers can attract more flows through more complex and costly distribution opportunities whereas the small tend to stay localised, with more limited distribution focus.
Increasing Sophistication of Investors
The hedge fund industry has experienced strong growth since its inception and this growth shows little sign of slowing. However, this growth is accompanied by an increasingly demanding, sophisticated and influential investor base.
Growth in the industry is strongly supported by the survey: well over half of hedge fund managers (61%) report that assets are rising. The trend is even stronger among larger managers – two-thirds of mid-sized firms report rising assets and all of the large firms surveyed say assets are on the increase.
Investors are increasingly aware that the sheer volume of assets they are pumping into hedge funds gives them considerable influence over how those assets are managed. As PwC identified inthe paper Alternative Asset Management in 2020, assets will only flow to the most compelling strategies and the most professionally managed firms. Investors will expect more from their hedge fund providers – more tailored, outcomebased hedge fund products which provide capital preservation and upside opportunities.
It is clear from the survey that performance remains the key sales factor. However, performance must go hand-in-hand with a strong brand, appropriate fee structures and a focus on good service and tax issues.
Excellence in all these areas must be accompanied by sound sales strategies and it is clear from the survey that direct engagement is the best medium for this. However, sales lead times can be long – nearly a quarter of survey respondents report that lead times are over a year. Such long lead times are likely to have a disproportionately large impact on small and start-up funds, which depend on rapid asset growth to survive.
Going forward, considerable thought will be applied to each and every fund launch. Nearly half of the managers in this survey anticipate launching a hedge fund in 2015-16. As investors become more demanding and require greater customisation, the research and business development activity before a
fund launch will intensify. Every product must be thoroughly vetted – for potential performance, for attractiveness to the market and for potential profitability.
Liquid alternatives: a rising tide?
The growth in liquid alternatives – primarily UCITS funds in Europe and mutual funds registered under the Investment Company Act of 1940 in the US, known as ’40 Act funds – has been prolific. With greater transparency, a strong regulatory environment, appealing liquidity terms, often lower fees and the ability to access a range of alternative strategies, growth in liquid alternatives is unsurprising. The survey bears this out, with 81% of firms that manage UCITS funds reporting rising assets under management (AuM). Meanwhile, some 87% of US managers of liquid alternative funds in the survey say AuM is rising in these strategies.
There are likely to be many more liquid alternative funds, with half of survey respondents in the UK planning to launch one in 2015-16. Nearly a third of the US firms are planning a liquid alternatives launch. However, just 14% of the continental European firms plan to launch a liquid alternatives fund in 2015-16.
Liquid alternatives operate in a densely regulated environment, which is more restrictive than the traditional hedge fund environment. Investment managers may need to alter their investment strategies to make sure that their investment portfolios are managed in compliance with regulations, and they will need appropriate infrastructure. In addition, liquid alternatives may have to be tailored for fund supermarket ranges, distribution platforms and other distribution channels, which involves significant negotiation between investment manager and distributor. This can result in a compromised alternatives distribution strategy.
(1) Source: HedgeFund Intelligence, AIMA.
(2) Source: Centre for Hedge Fund Research.