August 26, 2015

Mark Mannion: Opportunity knocks, but European alternative investment managers need to weigh a host of factors when entering the U.S. market

Mark Mannion

With the global hedge fund industry generally agreed to be around the $3 trillion mark after Q1-2015, the U.S. market continues to dominate, making up about two-thirds of the total. Its continued growth – coupled with a boom in ‘liquid alternative’ products that’s opened up the $16 trillion mutual fund market – has led large European alternative managers to revisit their distribution strategies for America.

Historically, many European alt firms have accessed U.S. investors via private placement, which requires larger hedge funds to register with the SEC and to make various regulatory filings. More recently, some of Europe’s larger alternative players have enhanced their strategies for accessing U.S. capital through a variety of newer approaches. Each of these comes with its own challenges, but the upside in terms of distribution reach is considerable.

As smaller hedge funds in the States grapple with allocations going to larger houses and regulation-driven cost creep, acquisition opportunities will present themselves to European players. While this approach may be expensive and carry a lot of integration effort, it can bring new strategies and enhanced distribution potential to the acquiring firm. Many managers on the Continent also have established U.S. limited partnership feeders as an entry point to their European- or Cayman-domiciled master funds. This may be a more cost-effective way to reach U.S. investors, but it doesn’t broaden distribution and still relies on private placement to professional buyers to raise assets.

Mutual Funds
Some European managers have looked to establish their own U.S. ‘40 Act’ mutual fund products, though barriers to entry in this sector are quite high. The funds require more costly operating systems than their UCITS equivalent, along with added corporate governance. The expense of building out distribution also can be prohibitive. The mutual fund marketplace is intensely crowded, with strong competition for ‘shelf space’ from established U.S. players. For European firms looking to establish a 40 Act presence, it may make sense to focus on a small number of distribution platforms and push product through those channels.

Another option for European managers is to enter the States in a sub-advisory capacity on an existing fund platform. Liquid alt products have soared in popularity and existing platforms offer retail investors alternative strategies from multiple managers through 40 Act structures. Recent estimates put the size of the liquid alts market at more than $200 billion and many see exponential growth over the next few years. But several factors should be weighed before going this route. While the asset-raising opportunity is sizable, players must remember management fees are lower than typical alternative products and a fund’s expense ratio must stay competitive. Also, 40 Act funds are highly regulated. European managers will have to run a strategy within the confines of applicable investment restrictions, which will differ from their flagship funds or UCITS products. Lastly, operational demands can be hefty, including daily valuations, new interfaces with U.S. service providers, and time-zone differences.

In summary, broadening distribution reach into America has the potential to deliver measurable benefits to European players. But these channels need to be carefully reviewed from a cost-benefit perspective and may demand patience before financial gains accrue. In fact, many products will have to show a three-year track record before they’ll be able to raise meaningful assets. For European alternative managers the key decision may be between going it alone or taking on a partner. Going it alone may make sense from a commercial and control standpoint, but it leaves the big challenges around distribution and achieving scale with the new entrant. Partnering with a third party will involve sharing revenue, but the payoff could be significant if that partner can do the heavy lifting and has a proven track record of raising money.