November 18, 2019

Alternative Asset Allocation on the Rise

Big Spenders: Top 5 public pension funds by Q3 hedge fund spend

Top 5 Public Pension Funds Spend on Alternative Asset Allocation

H1 2019 billion-dollar hedge fund winners, by AuM growth

$7.0Bn
6 MONTH CHANGE
$68.0Bn
JUL 2019
$61.0Bn
JAN 2019
Renaissance Technologies
$4.2Bn
6 MONTH CHANGE
$38.2Bn
JUL 2019
$34.0Bn
JAN 2019
Elliott Management Corporation
$4.0Bn
6 MONTH CHANGE
$38.9Bn
JUL 2019
$34.9Bn
JAN 2019
Millennium Management
$3.7Bn
6 MONTH CHANGE
$32.2Bn
JUL 2019
$28.5Bn
JAN 2019
Citadel
$3.3Bn
6 MONTH CHANGE
$11.7Bn
JUL 2019
$8.4Bn
JAN 2019
Tiger Global Management

Source: HFM Global Review Autumn 2019

Institutional Investors Flock to Hedge Funds for Defensive Positioning

The industry “concluded its strongest first half of a calendar year” in terms of performance, says HFR President Kenneth Heinz.

“Equity long bias funds” led the way, returning more than 10.6% on average. These are funds run by managers who believe in largely unhedged exposure to the market. The category of “event driven” funds was the third-best gainer of the first half, returning 6.9% on average. These funds look for specific triggers that will move a stock or credit. The volatility in financial markets this year has sustained institutional investors’ defensive posture, which is increasingly focused on relative-value strategies—investments that bet on the realignment of securities whose prices usually trade in sync but have diverged.

Investing $4.5 billion of the Florida Retirement System Trust Fund’s money in hedge funds, Ash Williams is defensively targeting relative value, along with broad-trend exposure in global macro and managed futures, both of which aim to profit from market reaction to economic or political events around the world. “When you look at the entire global spectrum of investible assets,” says Mr. Williams, chief investment officer of the Florida State Board of Administration, “it’s hard to find anything that offers reasonable value. This begs the need for more insurance-like exposure.”

First-Half 2019 Performance of Hedge Fund Strategies: Highlights

Jan-June 2019 Net Returns (%)

10.64%
Equity Long Bias
6.87%
Event-Driven
6.62%
Global Macro
5.44%
Fixed Income Relative Value

Source: Hedge Fund Performance, October, 2019, Wall Street Journal

Institutional Manager Selection is Key


“The best hedge fund managers don’t need to offer discounts because they are in high demand.”


According to a survey conducted by Intralinks, from an alternative asset allocation perspective, some LPs believe that hedge funds as an asset class can still work, provided they have access to the best managers and have good relationships in the market. “The best hedge fund managers don’t need to offer discounts because they are in high demand. If you have access to the best hedge funds, you’re going to be doing well and making money in this volatile market. Problem is, they are all closed,” says a U.S.-based allocator.

Alternative Asset Allocation: Quote Left Image

Conversationally, I think people are more optimistic about hedge funds over the near term, on the expectation there will be some sort of liquidity crisis or sociopolitical crisis. Hedge funds perform best when interest rates are higher but also when there are periods of strong market uncertainty. Based on conversations I’ve had with other family offices, people are more optimistic about hedge funds for the next 10 years than they were in regard to the last 10 years.

-U.S. based family office investment advisor

Alternative Asset Allocation: Quote Right Image

Perhaps in anticipation of choppier waters ahead, against a backdrop of ongoing geopolitical tensions and a slowing global economy, hedge funds were cited as the second highest overweight asset class.

Anthony Gordon is principal of the eponymous Gordon Family Office. He confirms that the general sentiment is that the family office will likely look to increase its hedge fund exposure by approximately 10% over the next 12 months, and that its overall exposure to alternatives will also rise by that amount.

“I’m not expecting to get market-like returns on hedge funds, I’m expecting exceptional returns,” says Gordon.

Some of the most famous managers continued to shine in 2018, such as Ray Dalio’s Bridgewater Associates, whose flagship Pure Alpha strategy generated 14.6% net of fees. D.E. Shaw Group produced similar returns for its Composite Fund, returning 11.2%, while another titan of the industry, Renaissance Technologies generated 8.5% for its Renaissance Institutional Equities Fund.

These managers are the apex predators, accessible to only the largest institutional investors.

Source: SS&C Intralinks 2020 LP Survey, October, 2019

Alternative Asset Allocation Trends

The survey, conducted by SS&C Intralinks, in partnership with PrivateEquityWire, canvassed the opinions of 182 LPs, of whom 40% had more than USD 5 billion in AUM and an additional 25% had more than USD 1 billion in AUM.

70% of LPs said RETURNS FROM their alternative asset allocations met or exceeded expectations

Broadly speaking, five out of 10 investors felt that returns from their alternative allocation programs over the past 12 months were in line with their objectives, as figure 1 illustrates. One in five LPs felt they had exceeded expectations.

Performance assessment Graph of Alternative Asset Allocation

Expectation Pie Chart of Alternative Asset Allocation

Interest in private equity shows no sign of abating

Drilling down specifically into individual asset classes, it becomes evident as to which GPs generated the best risk-adjusted returns.

Private equity, in keeping with its market-wide appeal, came out as the clear winner, cited by 45% of survey respondents (see figure 2).

Alternative Asset Allocation Risk Adjusted Returns Graph

Alternative Asset Allocation Overweight Graph

Commenting on the performance of private equity, a spokesperson from a leading U.S. public pension fund says, “With respect to the 10-year economic expansion we’ve witnessed in the U.S., purchase price multiples have been going up, public equities have been going up and it all helps to drive valuations and deal activity. Private equity has performed very well as a result of this. It’s hard to be disappointed.”

Sector preferences – Technology and Healthcare

As to where LPs would like alternative fund managers to focus their investment activities, there were two clear market sectors that stood out: Technology and Healthcare (see figure 5).

“I think Healthcare is the best sector for equity long/short strategies – there is such a wide range of things going on in that sector from regulatory changes to scientific advances, as well as great short opportunities coming from drugs that lack strong commercial potential. Technology has similar dynamics. Those two sectors are our biggest allocations and will continue to be,” comments a FoHF.

Sector specialist funds are appealing to investors because research suggests they outperform generalist funds. In private equity, for example, the average IRR on investments made by single sector funds between 2001 and 2014 was 22.6%, compared with 17.9% for investments made by generalist private equity funds, according to research by Cambridge Associates.

Alternative Asset Allocation Sectors Graph

Moreover, Healthcare-focused funds have proven to excel over the above time period, generating an average IRR of 34.4% compared with 19.2% by generalist funds.

Return Dispersion within Mid-Market PE Funds

“A lot of LPs are playing in the mid-market, as the survey suggests, but because of the dispersion of returns manager selection becomes even more important,” says a pension fund LP.

This year’s survey findings show an even clearer preference for mid-market private equity, with 61% of LPs favoring direct investment into this asset class, while only one in six saying they would focus on core real estate and regional infrastructure investment opportunities.

Source: SS&C Intralinks 2020 LP Survey, October, 2019

Expose your QP clients to the same alternative investment opportunities as the most sophisticated institutional investors.

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