Can the difference of one year move you years ahead?

Allocations to hedge funds rebounded and are now on par with private equity

Throughout 2021 the alternative fund industry has proven its ability to weather economic volatility and manage risk while producing returns that meet or exceed investor expectations.  Although private equity has continued to outpace investor expectations by a wide margin, hedge funds’ actively managed strategies proved attractive to investors, helping them to end several years of mixed performance and outperform investor expectations.  As such, allocations to hedge funds (28%) and private equity (27%) are now on par — a stark contrast to 2018 when hedge fund allocations (40%) outpaced private equity (18%) by a two to one margin, and in 2020, when private equity fund allocations (26%) exceeded hedge funds (23%).

Managers seeking growth are turning to “retail” channels as institutional allocations remain flat

Capital raising continues to be a priority, with two in five managers turning their focus to wealth management and retail channels for growth. Managers, looking to broaden their LP base, given limitations that institutional investors may have on additional flows to alternatives, are identifying retail, High-Net-Worth and Family Office investors to be favorable segments for raising assets.

Investor scrutiny on managers’ DEI policies is increasing

Alternative fund managers have recognized that effectively managing talent and incorporating diversity, equity and inclusion (DEI) policies and programs into both corporate governance and investment strategies are a core business imperative. With investor scrutiny increasing, managers that can successfully attract and retain talent and operationalize and take DEI to the next level, can realize increased investor interest and growth. It’s worth noting that this increased investor scrutiny may be due in part to recognition that effective diversity policies yield better investment outcomes, and that investors are being held accountable for fostering diversity by their own stakeholders, i.e., boards and shareholders for corporate funds, and public entities.

Hybrid work will remain a permanent feature of the future work environment

In 2021 “the war on talent,” or the ability to attract and retain workers, may be one of the greatest challenges facing the alternative fund industry today.  Employees, who worked remotely during the pandemic, having experienced an improved work-life balance and other benefits associated with working from home, have an advantage when it comes to choosing who they will work for, and how, when and where they will work.  In response, alternative fund managers recognize that they need to create an attractive, flexible, safe and inclusive working environment that maximizes employee productivity.  Hybrid work plans, offering some of the flexibility that working from home offers, achieve the desired result, and will become a permanent feature of the future work environment.

An increasing proportion of investors are investing in ESG products

In 2021, with environmental and social justice issues dominating the news cycle, the environmental, social, and governance (ESG) movement has taken “center stage,” with alternative fund managers formalizing their ESG policies at both the management company-level and in their investment strategies to satisfy investor demands. These demands include investing in companies that actively incorporate sustainable practices into their corporate strategy planning and disclosure efforts and investing in companies that offer sustainable products.

One in five investors say they decided not to invest with a manager because their ESG policies were inadequate

Although most managers are providing their ESG policies and procedures upon request, investors want increased transparency in reporting to demonstrate that their managers are meeting their UN Conference of the Parties (COP) ESG requirements. In response, managers point to a lack of quality data as one roadblock to adoption — but adopt they must, for in the past year, one in five investors decided not to invest with managers without appropriate policies, citing inadequate ESG integration as a primary reason for their decision. As a result, managers who neglect this trend may lose out on investor interest and capital allocations.

Nearly 30% of alternative fund managers participated in the SPAC market

Perhaps the most pronounced of the strategy innovations during 2021 has been the increased focus on private investing, with hedge funds making private company investments to enhance returns and attract capital, with investors becoming comfortable with this strategy as well. Private investment opportunities have been significant contributors to performance during 2021 while also providing a diversified return profile against public market investing.   

In addition, alternative fund managers have been active participants in the SPAC market, with one in three actively engaged or considering sponsoring or investing in a SPAC, as evidenced by the Q1 surge in activity.

One in four hedge fund managers expect to increase crypto exposure

Cryptocurrencies and the digital asset ecosystem perhaps garnered the most mainstream public interest during 2021.  Alternative fund managers have become more active participants, drawn by uncorrelated return profiles and continued investment in institutional-grade infrastructure to support this evolving asset class. .

Besides sustainable investing, improvements to data and technology will shape the future of asset management

In 2021 and beyond, investors will continue to embrace the value of alternative funds to diversify their investment portfolios, mitigate risk and future-proof their returns. But deficiencies in digital infrastructures and IT capabilities still exist, impairing increased investor reporting requirements surrounding both financial and nonfinancial imperatives.  More than one in three managers surveyed point to improvements in data and technology as important in shaping the industry going forward. Managers increasingly need to invest in technology, while data engineering and data science professionals are essential resources in evaluating, collating, processing, and interpreting data from a myriad of sources to drive intelligent investment decision-making.

Nearly half of hedge fund managers are paying closer attention to the impact of retail investors

In addition, nearly half of the hedge fund managers interviewed and 60% of managers in the US say they are more cognizant of retail investor behavior and its impact.  In response, managers have taken a variety of steps, including modifying their risk management procedures and setting exposure limits, investing in social media monitoring tools, and carefully examining how they express their investment propositions. In some circumstances, in addition to more careful monitoring of concentrated positions, managers have altered trading behavior to reflect short positions with derivatives rather than physical securities to avoid both public reporting of exposures and limit risk in periods of volatility.