Assets under management in alternative investments are projected to reach $17 trillion by 2025.1 Alternatives, once a small part of institutional portfolios, are now so mainstream that strictly speaking they might need a new name. But that’s hardly top of mind for the decision makers at alternative management firms, who despite recognizing they are having a moment also realize there are challenges to continued growth.
A series of surveys2 of 100 institutional investors and 100 alternative asset managers conducted by BNY Mellon and Mergermarket reveals that managers believe they will have to change to meet investor demand and expectations.
Pressure points on alternative managers have origins beyond investor demand, too. There’s fierce competition and continual product innovation in the space, not to mention macroeconomics (hello inflation). These forces and others are likely to drive structural change in alternative asset management firms.
“I think there will be structural change,” says Kenny King, Head of Alternatives, Asset Servicing, BNY Mellon. “Increased competition is leading to an expansion of product offerings. A good example is real estate, historically considered a product for institutional investors. Now you see real estate firms and products being offered to high net worth and retail investors.”
Seeking differentiation
Increased competition also drives alts managers to look for ways to stand out from the crowd. “Firms are trying to differentiate themselves by creating new flavors of the same product. If vanilla, strawberry, and chocolate have been your thing, competition will push you to create your version of cookie dough ice cream,” says King.
Another trend King is observing is the widespread appetite for co-investment. He notes that 10 years ago co-investing was a relatively new area of interest for institutions. In the surveys, however, 100 percent of respondents said the opportunity to co-invest was highly or very important.
Beyond macroeconomics, the economics of the industry are changing, too, forcing alternative managers to adapt. “Investors want lower fees because of the ETF models, but alts have always been able to charge a premium. To continue to do that, you really must show you’re adding extra value or there is something genuinely premium about the product,” says King.
As they anticipate growth, survey respondents indicated that cost cutting was their number one strategic priority. That will likely lead to more outsourcing of middle- and back-office functions and talent.
“We recently worked with a large credit manager to lift out their entire back office,” says King. “Five years ago, there wouldn’t have been much demand for that, but as the cost for front office talent increases it puts pressure on other cost centers that include spend for health insurance, real estate, and technology costs. Firms are trying to find ways to better leverage that spend.”
Expectations around DEI and ESG
All asset managers are increasingly expected to demonstrate a commitment to diversity, equity, and inclusion (DEI) in everything they do. RFPs now routinely include requirements to address DEI. In large part, this has been driven by asset owners and the largest asset managers.
“One of the hardest things for alternatives managers today – and I think they’re trying to get there – is how to be authentic in their view of DEI. How do you build a policy that is real and sustainable?” says King.
There are parallels and overlap between DEI and ESG, King says, that will be imperative for alternative managers to address holistically as they delve more into the high-net-worth channel of investors on the retail side – especially as new generations of investors emerge.
“Talk to anyone in their 20s anywhere in the world, and they are very aware of DEI and ESG. They care about what their managers are investing in and the makeup of the investment team,” says King. “Right now, alternative managers don’t know how to be consistent in addressing this across the board – but they have to get there.”
Transparency is key, of course, but it doesn’t solve the challenge on its own. An alternative manager willing to partner with its investor base – be it institutional alone or combined with high-net-worth retail – could still find it an uphill climb to put together a cohort of investors. It’s a climb worth taking, however.
“How do you create a product that’s ESG that fits different populations?” says King. “How do you build transparency into not only the investments, but the thought process, too? How do you make certain you appeal to a wider range of investors without isolating one group or another who may have an essentially similar viewpoint but with nuanced differences? There’s a growth opportunity for managers who find answers to those questions.”
One way of meeting the challenge is giving ESG and DEI an actual seat at the table. “Fifteen years ago, it’s unlikely an alternatives firm would have thought about hiring someone dedicated to ESG or DEI, but today that is something alts managers need to consider to successfully integrate those beliefs throughout their organizations in a way that can be seen and trusted by investors. The firms that get ahead on this are the ones that will apply real resources to it,” says King.
Emergence of retail as an opportunity
A trend that alternatives managers are likely to see as a significant growth opportunity is greater participation in alternative investing by high-net-worth retail investors.
“With the growth of wealth that’s occurred over the last 10 years, there’s a lot of ‘smart’ retail money,” says King. “If they’re going to invest in alts, they’re not using that as the ATM. With rates being low, it’s a diversifier for their long fixed income exposure.”
The realization that all that retail money adds up to something significant is perhaps why a third of alternative managers in the survey said they were going to launch a product for retail. “How they address distribution will be interesting to see,” says King. “Consider this: Everyone wants to tap the retail market in Asia, which is highly digitized – people do almost everything on their phone in China, for example. Imagine if you could buy an alt fund on your phone. That would be game changing.”
As more retail investors enter the alternatives space, demand for customization – which is still relatively new even among institutional investors – is likely to surge. The key is building customization with scalability.
“Within the context of controlling costs, scalability will be vital as demand for customization rises,” says King. “And it will rise. Investors in private markets will want access to specific sectors and sub-sectors, and managers will have to provide that control for them along with transparency, potential liquidity, and governance.”
“Returns will always be important,” says King, “but there are a lot of things colliding for alternative managers right now. Managing those collisions, keeping costs in check, and delivering solutions that meet the needs of investors will define the eventual winners.”
1 https://www.bnymellon.com/us/en/insights/content-series/the-race-for-assets.html
2 https://www.bnymellon.com/us/en/insights/from-alternative-to-mainstream-series.html
Disclaimer
BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may be used to reference the corporation as a whole and/or its various subsidiaries generally. This material does not constitute a recommendation by BNY Mellon of any kind. The information herein is not intended to provide tax, legal, investment, accounting, financial or other professional advice on any matter, and should not be used or relied upon as such. The views expressed within this material are those of the contributors and not necessarily those of BNY Mellon. BNY Mellon has not independently verified the information contained in this material and makes no representation as to the accuracy, completeness, timeliness, merchantability or fitness for a specific purpose of the information provided in this material. BNY Mellon assumes no direct or consequential liability for any errors in or reliance upon this material.
BNY Mellon will not be responsible for updating any information contained within this material and opinions and information contained herein are subject to change without notice.
BNY Mellon assumes no direct or consequential liability for any errors in or reliance upon this material. This material may not be reproduced or disseminated in any form without the prior written permission of BNY Mellon. Trademarks, logos and other intellectual property marks belong to their respective owners.
© 2022 The Bank of New York Mellon Corporation. All rights reserved.