28 May 2020

Reshaping the Money Management Business

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Due to the uncertainty in long-term returns for equities and fixed income and declining funding ratios, institutions have poured tens of billions of dollars into alternative investment strategies — real estate, private equity, hedge funds, venture capital, real assets and credit — at the expense of long-only money managers. The inexorable move into alternative investments by institutional investors is reshaping the money management business.

According to Pensions & Investments’ data, close to $1 trillion invested in alternative strategies by the 200 largest U.S. defined benefit plans as of Sept. 30, up from $680 billion as of Sept. 30, 2008, money hemorrhaging from old-fashioned managers over the past 15 years has been substantial.

A number of large, institutionally oriented private equity and hedge fund managers wasted little time in expanding their businesses from a single focus to converge a broader spectrum of alternatives investment approaches including:

  • The Blackstone Group LP, which managed $271.7 billion in private equity, real estate, credit, hedge funds of funds, credit and mutual fund strategies;
  • The Carlyle Group LP, which managed $198.9 billion in private equity, real estate, and hedge funds- and real estate funds of funds;
  • Apollo Global Management LLC, which managed a total of $159 billion in private equity, real estate and credit strategies;
  • KKR & Co. LP, which managed $102.3 billion in private equity, real estate, energy and hedge funds-of-funds approaches;
  • Fortress Investment Group, which managed $62.5 billion in private equity, credit, global macro hedge funds and long-only strategies; and
  • Och-Ziff Capital Management Group LLC, which managed $42.6 billion in hedge fund, real estate and credit strategies.

Hedge fund managers are moving away from their more liquid flagship strategies that have monthly or quarterly liquidity toward lockup periods of between three and five years.

Longer lockups 

Crestline Investors Inc., Fort Worth, for example, has maintained its hedge funds-of-funds commingled and separate account strategies, but led by high-returning opportunities, moved into credit- and distressed-recovery funds with much longer lockups. As early as 2004, the firm's investment team found that the liquidity premium is highest in the one- to three-year lockup range and going forward, continued to find that credit opportunities were much better suited to a fund vehicle with less liquid redemption terms. As of March 31, Crestline's opportunistic and private credit strategies accounted for 36% of total assets of $7.6 billion, growth of $2.7 billion since their introduction in 2004. Assets managed in hedge funds-of-funds business totaled $2.7 as of the same date, while $2.2 billion was managed in hedged beta strategies.

Specialist alternative managers are being encouraged to broaden their investment capabilities by two main factors — investor demand for solutions-based approaches and a need to diversify beyond their original forte. Institutional investors want more global alternative investment strategies from a single manager.

Private equity managers, especially midsized firms, are more readily facing the fact that their ability to raise money is highly dependent on the performance of their last fund. And big private equity money management firms are being goaded into adding new investment strategies because the days of raising the next ever larger buyout fund are not certain anymore.

Sources were divided on whether building, recruiting or buying the needed investment capability is the best option for alternative and traditional money managers. While there are plenty of hedge fund startups that are good, but struggling to raise assets, for acquirers to choose from, the success rate of implementing new investment teams remains low.

Grosvenor Capital Management LP, Chicago, is one of the few firms to have successfully incorporated new investment teams in its culture. A hedge funds-of-funds manager by legacy, Grosvenor managed $25 billion for an institutional client base that increasingly used Grosvenor to create customized hedge fund separate accounts or for advice on investing directly in hedge funds. In January, the firm completed its acquisition of the Customized Fund Investment Group from Credit Suisse Group AG. The Swiss bank was forced by the Volcker rule to sell some of its riskier assets. The customized unit managed $20 billion in private equity, real estate and infrastructure funds of funds.

Hedge fund-like 

One part of the investment management industry is large mutual fund firms with broad distribution networks that have been hiring or acquiring hedge funds-of-funds managers to run daily-valued mutual funds using hedge fund-like strategies. An example includes Fidelity Investments' hiring of Arden Asset Management LLC and Blackstone Alternative Asset Management as subadvisers for funds on its wealth management platform.

Eventually, daily-valued hedge fund-like mutual funds will likely make their way into defined contribution plans or at least as a component in their target-date funds. But for the moment, most of the demand for alternatives mutual funds is from retail investors.

One way to make the industry's growth into alternatives clearer is to look at a spectrum on which the most liquid investments, exchange-traded funds for example, are on the left side; mutual funds, liquid alternatives and hedge funds are in the center; and the least liquid investments, namely real estate and private equity, are on the right.

It can be predicted that most of the growth over the next three to five years will be in the middle of the liquidity spectrum as retail investors seek better returns, but noted that less liquid strategies also will grow, just more slowly.

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