Table of Contents
Drastic asset allocation changes have transformed the asset management industry. Fears a traditional 60/40 portfolio can no longer provide the desired risk-adjusted returns are inciting investors – and their providers – to explore a wider range of alternatives strategies. Compound annual growth rates for alternative investments may be slowing in the short term as liquidity concerns rise and institutional investors approach their target allocations, but global demand remains resilient.
Resilient global demand
Data provider Preqin predicts private capital assets under management will almost double to USD 18.3 trillion by 2027, from USD 9.3 trillion at the end of 2021, “as investors continue to seek alternative sources of returns in an uncertain economic environment”. Asset classes such as infrastructure, private capital that historically performed well in more volatile markets and that offer lower exposure to inflation risk are expected to see particular demand and growth. “Private debt include also an appealing relative value, inflation-linked cash flows and an illiquidity premium over listed assets,” observed BNP Paribas Asset Management’s most recent investment outlook.
While institutional investors will continue to target an average allocation to alternatives of 20%, even surpassing 30% in the United States, individual portfolios hold only 2% of their assets in alternatives. Rising retail interest in alternatives will be key to the next wave of private capital growth – especially among high-net-worth investors (HNWIs), who have long eyed the diversification and long-term yield possibilities. Individual investor access to most alternatives has been difficult historically due to the lack of transparency, high investment thresholds and low level of knowledge regarding the investment opportunities. Now, technology and regulatory changes are providing more opportunities to invest in alternative solutions.
A 2022 CAIS-Mercer survey reported that almost 90% of financial advisors in the United States intend to increase allocations to alternative asset classes over the next two years as investors search for diversification, capital preservation and/or uncorrelated returns. Clients are more open to using both new investment products and new structures, such as interval funds, to invest in alternatives, it added. Similar trends are observed in Asia and Europe. According to a Cerulli survey, half of European wealth managers’ clients are likely to significantly increase their demand for alternative products.
Alternative attractions for asset managers
For generalist asset managers, booming alternatives interest among the various investor cohorts offers opportunities to tap into an area of structural growth potential. Plus firms can lock in investor capital for longer at higher fees, offsetting the fee pressures seen most notably from the shift to passive investing.
EY’s latest Global Alternative Fund Survey found managers are increasing their product offerings in areas such as illiquid credit, real estate, private equity, venture capital and opportunistic or special situations, and are “incorporating differentiated investing criteria within an existing strategy, such as private market investing within a hedge fund.” Alternative managers are also expanding distribution of their existing and hybrid products to new customers, including retail investors.
Generalist asset managers well positioned to deliver
While competition for the burgeoning retail alternatives market is intensifying, generalist asset managers are well positioned to take advantage of their distribution network. Retail is in generalist managers’ DNA and most of them, notably in Europe, belong to financial groups with an in-house retail network. They already have brand recognition, credibility, existing relationships and experience in advising end-investors.
Generalists have demonstrable advisory experience in asset allocation, giving them credibility with investors. But they are up against alternatives specialists. In many cases, specialists have developed customised offerings and fee structures to create an alignment of asset owner and manager interests. Can generalists find flexible ways to incentivise investors and remunerate staff that do not create damaging internal tensions? Alternative funds typically have long lock-in periods, but will generalists’ employees stay long enough to benefit? And how can this alignment of interests translate to a retail environment?
Need for deep capabilities across multiple areas
Creating a successful alternatives business is no simple task, requiring deep capabilities across multiple areas.
Generalist asset managers, with their established B2C and B2B2C networks, have a leg up on their specialist alternatives rivals in the retail space. Distribution in Europe is fragmented, with multiple, often idiosyncratic country-based models, requiring strong relationships with multiple partners (fund platforms, banks, etc.). Generalist asset managers therefore have a key advantage in distributing alternatives to investors compared to alternative managers that previously only focused on HNWIs and institutional investors. However, generalists will need to ensure their sales and distribution teams have appropriate knowledge of the alternative asset classes and complex strategies the firm is offering.
The retail market is highly regulated with many market specificities. Managers need local compliance knowledge and robust, efficient processes to meet their evolving responsibilities and the associated costs.
Complying with stringent Know Your Customer rules across a high volume of clients, for example, demands automated tools and skilled teams to collect, analyse and act on the data. Institutional investors’ information tends to be stable, whereas retail clients commonly move address, switch married names and change tax status. Having the capabilities to cope, as generalist managers tend to do, is vital.
Specialist managers have the advantage of (sometimes highly niche) alternatives investment expertise. Generalists will need skills and experience in selecting the underlying assets and managing the strategies.
Various options are available to fill any skills gap. Firms can opt to build a team from scratch. They could buy in the capabilities by recruiting a team or acquiring a rival manager. Alternatively, they can appoint a sub-advisor or pursue a fund of funds approach.
The main challenge is to find the right model to optimise profitability. Building a team allows firms to capture 100% of the revenue, but is slower and more expensive than a sub-advisory or fund of funds structure.
Talent availability is a further consideration. With expertise at a premium, talent management is now a leading concern for both managers and investors, according to the EY Global Alternative Fund survey. Talent recruitment, onboarding and retention have become a priority focus for managers, while more than half of investors said scrutiny of their fund managers’ talent programmes and policies has increased over the past two to three years.
Attracting and retaining talent may demand more creative approaches to compensation, working arrangements and roles. Alternatives teams, and their investment capabilities, then need to be integrated into the wider organisation.
Expertise demands are not limited to investment disciplines. Alternative asset classes, the fund structures used and clients’ servicing expectations impose different operating demands to a traditional fund. They may feature complex fee calculations and accounting treatment. Capital calls need to be managed. Regulatory reporting responsibilities differ. Asset managers must ensure their operating model can extend to these new areas of activity.
A multi-asset offering – especially one incorporating alternative investments – requires a true multi-asset class operating architecture able to cope with the different asset specificities. Few individual software solutions have the necessary functionality breadth covering traditional and alternative assets. Firms using multiple platforms to handle different asset types will need to solve the resulting data aggregation and management challenges to ensure they can meet best practice client servicing and compliance standards. The solution environment must also support firms’ digital transformation efforts across all their strategies.
How to ensure a sustainable growth in Alternatives
Educating investors, especially prospective retail clients, will be vital to sustainable growth. Pressure on asset valuations and the potential for distressed sales will throw up investment possibilities. Private credit in particular will likely be a beneficiary of this period of rising interest rates and uncertain economic conditions according to the EY survey, creating a credit cycle that will offer “interesting and lucrative” opportunities.
But investor patience will be vital. Illiquid assets demand long-term investment horizons. Firms will need to help foster that longer-term investor mindset, and where required manage any liquidity gap between fund terms and underlying assets.
In today’s more volatile environment, having a sophisticated technology framework and expert people across all business areas – from front-office investing and client relations to operations and compliance – will be ever more important too.
The value of a partner provider
Strong middle- and back-office support from a trusted service provider can play a pivotal role in asset managers’ expansion aspirations.
Managers depend on ready access to accurate data. They need investment monitoring, multi-asset class fund accounting, asset valuations, comprehensive client and regulatory reporting, performance analytics and financing solutions.
BNP Paribas’s Securities Services offering is designed to help. Our market, banking and outsourcing capabilities provide a full suite of multi-asset services, notably in fund administration, financing, transfer agency, custody and depositary. Backed by an integrated bank model from a leading global group, best-of-breed technology and multi-local expertise, we can support different types of funds, asset managers and investors with an efficient, holistic service that meets their local, regional and global specificities.
Communication intended for fund managers.
 The Future of Alternatives in 2027, Preqin, https://www.preqin.com/future-of-alternatives-2027
 Investment Outlook 2023 – Investing in an age of transformation, BNP Paribas Asset Management, https://www.bnpparibas-am.com/portfolio-perspectives/investment-outlook-2023-investing-in-an-age-of-transformation/#resilience
 Institutions typically invest between 30-50 per cent of their assets in alternatives, according to a study by McKinsey mentioned by FT
 The Future of Alternatives in 2027, Preqin
 The state of alternative investments in wealth management, CAIS-Mercer, November 2022, https://info.caisgroup.com/state-of-alternative-investments-in-wealth-management
 Global Cerulli Report 2022
 Can resilience shape a shifting landscape? EY, November 2022, https://www.ey.com/en_us/wealth-asset-management/global-alternative-fund-survey