Private equity and other alternative investments are gaining favor among allocators at the expense of hedge fund managers, which are facing challenges from market conditions and changing investor preferences, according to EY's annual global alternative fund survey, which was previously called the EY global hedge fund survey.
A fifth of investors said they planned to decrease allocations to hedge funds in 2018, continuing a multi-year slowing of allocation appetite for hedge fund products, while a third of investors planned to increase allocations to private equity and only 9% to decrease them in the next three years.
"Alternative asset managers are grappling with a whirlwind of changes, and they can either act now to address industry disruptions — ranging from technological innovation to products and competition from new players — or admit defeat and lose competitive market share," Natalie Deak Jaros, co-leader of EY's global hedge fund services, said in a statement.
"In order for alternatives to stay ahead, they need to appease investor demand for customization, implement technology that augments investment decisions, and hire the proper talent to both manage technology and bring outside thinking to the traditional financial services mindset."
Greenwich Associates conducted 102 interviews during the third quarter with hedge funds, representing over $1.1 trillion in assets under management; 103 interviews with private equity firms, representing nearly $2.2 trillion in assets; and 65 interviews with institutional investors, representing over $2.7 trillion in assets.
Increased Competition
EY reported that hedge fund and private equity managers are increasingly competing with one another to tap into investors' desire for nontraditional products. A majority of investors surveyed said they were increasingly allocating to such offerings, including private credit, real estate and real assets.
Forty-six percent of private equity managers and 35% of hedge fund managers reported having a private credit offering. In addition, three in 10 hedge fund managers said they offered a private equity product, and two in five private equity managers had hedge products.
EY said the diversification of product offerings was directly resulting in convergence as managers across all strategies develop expertise and branch out to a variety of alternative offerings.
The survey found that besides demanding nontraditional products, allocators increasingly want to be more active partners with their managers, and to have a voice on investment decisions and operational matters.
More than one-third of investors said they planned to increase their behavior as "active LPs," and 32% said they would continue to build out investment capabilities to replicate the strategy internally without the assistance of a third-party external manager.
Not only that, but investors are becoming more active partners with their managers in demanding that product offerings be tailored to their needs. The survey found that more than a third of hedge funds were responding to this growing demand for customization by increasing or planning to increase the number of separately managed accounts and funds of one they offer.
EY noted that these offerings appease investor demands, but create operational headaches for alternative asset managers.
