As a result of a “multiyear global research effort” in collaboration with Institutional Investor, studying the alternative investment landscape, consultant McKinsey has, in a recent paper, offered advice to traditional asset managers willing to take the plunge into “the next wave of growth in asset management.”
Investors, Especially in North America, Want Alternatives
As the below chart shows, the ongoing surge of interest from institutional investors especially encompasses several distinct alternatives classes: private equity; hedge funds; real estate; infrastructure and commodities. Taking hedge funds specifically, North America and Europe are heading in different directions. In 2009 the average portion of a North American institution’s total portfolio allocated to hedge funds was just 4.2 percent. By the end of 2013, that number, it is estimated, will have risen to 9.0. In Europe, though, allocations to hedge funds are decreasing and are expected to continue to decrease. The average was 3.7 percent in 2009, 2.8 in 2010, and is expected to be 1.9 in 2013.
In the PE area, and in real estate, on the other hand, the trends in North America and in the EU are in accord – allocations are up.
Allocations aren’t rising simply because fees are dropping. Fees have proven quite sticky, and the industry participants interviewed for this paper expect that will remain the case. On the one hand, half of the institutional investors surveyed expect to pay a management fee of between 1 and 1.5 percent of net assets in 2013, and yes that is down from the range of 1.5 to 2 percent they say they paid in 2010. On the other hand, far fewer (only 20 percent) expect that there will be any change in the performance fee, which tradition sets at 20 percent of annual net profit.
The reason for the increased interest in alternatives, then, isn’t that the alternatives’ managers are slashing the price of their services. It is, rather, a discontent with the return to be gained from traditional investment. “Even with downward pressure likely over the next few years, revenue yields for institutional alternative products should remain well above the 35 bps average earned on today’s traditional institutional products,” McKinsey says. That will continue to draw buyers.
Traditional asset managers, then, will want to “gear up” to offer their own clients a wider range of alternatives. One factor holding some back from taking the plunge is a concern that they aren’t in a good relative position to win in the alternatives world.
The graph below shows the results when asset managers are asked to rank various types of firms on a scale of 1 to 5 in terms of their ability to “win in derivatives.” The higher numbers, 4 and 5, are those that reflect optimism. Ninety-one percent of the US respondents (and 69 percent of the EU respondents) believe that boutique/specialist players are well or best positioned for using alternatives. Only 32 percent in the US and 44 percent in the EU, express such optimism about traditional asset managers.
McKinsey believes that such caution is justified. Traditional asset managers do face organizational challenges that they must address before they can “succeed in the alternatives space:” they need to beef up their risk management capabilities, develop technical knowledge of the new products, and resolve “broader organizational and cultural issues.”
One way managers sometimes try to overcome these barriers is by entering into a strategic partnership with an alternatives boutique “to stress test strategic fit before making an acquisition.” But if their partnership is not carefully structured, the asset manager could find itself providing a valuable distribution arm to the boutique “with little benefit to itself.”
For asset managers who face either the desire to buy or partner their way into the alternatives world or the “long hard road” of building their own alternatives operation internally, McKinsey offers the following pieces of advice:
- Treat alternatives as a business, not an asset class or product set
- Focus on the specific strategies and asset channels where you are best positioned to succeed
- Leverage distribution strength and client servicing capability
- Address organizational and cultural issues, and
- Improve risk management and client reporting.