Alternative investments have become an established part of many sophisticated investment strategies. But what do Asian asset owners need to be aware of as they seek to increase their allocation to alternative asset classes? Experts at the BNY Mellon Asia Pacific Asset Servicing Client Leadership Summit in Beijing weighed in on due diligence, fees and emerging managers.
Panel Discussion: Alternative Investments – The Next Big Thing (From left to right) Mark Nelligan, Head of Alternative Investment Services & Structured Products, Asia Pacific, BNY Mellon; Murray Steel, Chief Operating Officer, Man Group Asia; Ajay Narang, Head of Asia Sales, Preqin; Darren Bowdern, Head of Financial Services, Tax, KPMG China
Allocation to alternative assets is accelerating globally. “Preqin estimates that the alternative investments industry will grow by 59% to $14 trillion between 2018 and 2023, driven largely by investors’ need for alpha, decreasing opportunities in public markets, and a growing pool of institutional investors” said Ajay Narang, Head of Asia Sales, Preqin.
Here in Asia, asset owners are increasingly adopting alternative strategies to diversify their portfolios to reduce volatility, offering an inflation hedge, providing higher returns with low correlation to other asset classes, and generating reliable income. At the same time, the economic and political environment across the region is creating attractive opportunities in alternative investments.
“We foresee China emerging as a key source of alternative investment capital in the next five years, with Southeast Asia and China as key global investment targets,” Mr. Narang revealed.
He pointed to healthcare, fintech, and artificial intelligence as up-and-coming targets for venture capital, with infrastructure, private debt and real estate also remaining high-growth alternative investments.
What factors should Asian investors consider when implementing an alternative investment strategy?
While some investors may simply send very junior staff to “tick the boxes” during the due diligence exercise, this is the wrong approach according to Murray Steel, Chief Operating Officer, Man Group Asia. The point of due diligence is really to get to understand the people, processes and culture of an asset management company before you invest with it, to discover whether it lives by the values it espouses.
“Allocators that take their due diligence seriously ask questions on everything from financial practices to how we book trades,” Mr. Steel explained. “They may want to meet our operations managers, investment managers, and financial and legal teams – plus our asset servicing partners, like BNY Mellon. Some may have people sit with us for several days to learn about our trading and investment process or send someone on secondment as an intern or observer for several months.”
Due diligence has historically been more critical in the alternative investment sector than in the traditional investment space.
“Up to now, the alternative industry has self-regulated through due diligence driven by investors. This is set to remain the case, though increasing regulatory oversight is a reality for most players,” Mark Nelligan, Head of Alternative Investment Services and Structured Products, Asia Pacific, BNY Mellon, pointed out.
“The hedge fund industry has obviously been regulated for many years, but the private equity and real estate industries have largely remained unregulated in Asia,” Darren Bowdern, Head of Financial Services, Tax, KPMG China, added. “General Partners (GPs) managing multiple investment strategies – across private equity, hedge and real estate – now tend to be licensed in the jurisdictions in which they operate and thus regulated. And even the pure private equity, private credit and real estate funds are now coming under more regulatory scrutiny in Hong Kong and Singapore, albeit with a light touch.”
Fees are a key aspect of due diligence, and many investors recognize that headline fees cannot be viewed in isolation from a fund’s total expense ratios.
“For some alternatives, there is a trend towards a model where nearly all management costs are passed through the fund and so do not appear as headline fees. This is a model that is attractive to many portfolio managers and traders. Clients need to pay attention to the fee models of the managers they are selecting.” Mr. Steel explained.
Mr. Narang concurred. “There is ample liquidity in the market today, so the power lies with the GPs with the best managers. Fees are secondary to allocations in many cases. Furthermore, LPs can find other ways to reduce fees, such as co-investments. For them, it is really about developing relationships with fund managers and finding other ways to work together.”
Funds today are larger than ever. According to Preqin’s data, the majority of capital allocated in the last year went to funds larger than $1 billion. Five years ago, such funds were considered big. Today, they are unremarkable, with an average private equity fund now topping $5 billion”, said Mr. Narang.
He reported that it is not surprising to see investors taking a long-term approach and deploying capital to the largest and safest funds. 38% of private equity investors that Preqin interviewed for its new H1 2019 Alternatives Investor Outlook expects a significant market correction in the next 12 months.
Mr. Bowdern countered that some capital allocators are seeking diversity, looking particularly to boutique GPs with particular sector expertise.
“We are also seeing a move away from traditional asset strategies – focused on private equity, private credit or real estate – towards impact funds, core funds, environmental, social and governance (ESG)-specific funds and infrastructure plays. Investors like a mixture, but it is a more competitive environment,” he said.
In such a complex landscape, it all once again comes back to due diligence.
“Big allocators that find a couple of good small funds to invest in can negotiate good fees, develop good relationships and also get first call on capacity. But the most important thing is to look at governance,” Mr. Steel added. “Small funds may have some great managers, but if the governance around them is not satisfactory, they must be rejected.”
The views expressed herein are those of the panel speakers and may not reflect the views of BNY Mellon. This does not constitute legal, tax, accounting, investment, financial or other professional advice on any matter and does not constitute a recommendation by BNY Mellon of any kind.
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