The just-released 2020 EY Global Alternative Fund Survey—the fourteenth annual survey of hedge fund and other alternative asset investors from the consulting and accounting group also known as Ernst & Young—has found that despite extreme levels of market volatility, higher trading volumes and social disruptions due to COVID-19, alternative fund managers persevered, and even exceeded, performance expectations from investors.
EY’s report was based on interviews conducted by researchers at Greenwich Associates between July to September 2020. Subjects included 110 hedge funds representing over $1.8 trillion in assets under management and 127 interviews with private equity firms representing nearly $2.7 trillion in assets under management, and 73 interviews with institutional investors (funds of funds, pension funds, endowments and foundations) representing over $1.4 trillion in assets under management.
The survey found that total allocations to alternative investments remain relatively unchanged year-over-year, but competition between asset classes continues to intensify. Consistent with a multiyear trend, investment allocations to hedge funds dropped once again to just 23 percent in 2020, down from 33 percent in 2019 and 40 percent in 2018.
Investments in private equity and venture capital remained stable at 26 percent, while investments in private credit more than doubled, from 5 percent in 2019 to 11 percent in 2020, with market participants anticipating that covid-19 will be a catalyst for a new credit cycle that will create opportunities for these managers.
In response, EY found, hedge funds have been expanding their offerings, or tapping into new markets, such as private asset classes in particular, via a variety of unique structures. More than 40 percent of hedge fund managers are currently offering co-investment vehicles or best-idea portfolios, and, nearly 20 percent of managers are creating side pockets, which allow investors an election to participate in illiquid investments within a broader portfolio.
This year’s market has seen explosive growth in special-purpose acquisition companies (SPACs), with a nearly threefold increase in the amount raised in SPACs compared to 2019. Managers have found these permanent capital structures to be an attractive way to raise capital, acquire companies and fast-track them toward the public markets. Per EY, while many managers are sponsoring these deals, traditional active managers have featured strongly in these transactions.
Hedge fund managers expect that COVID-19 market volatility will drive a significant interest in active management, with over half of hedge fund managers (52 percent) surveyed believing that the impact of COVID-19, and the related market volatility, will increase investor interest in active management. Nearly one-third (30 percent) of investors responded that the COVID-19-related market volatility has, in fact, increased their interest in actively managed alternative investments.
The alternative investments industry rose to the occasion surrounding the COVID-19 pandemic in terms of investors’ expectations and managerial performance. Investors generally felt that their alternative fund managers either met or exceeded their performance return expectations, with 58 percent of hedge fund investors and the majority (81 percent) of private equity investors noting that their managers met or exceeded performance expectations during the market volatility that occurred as a result of the pandemic.
Almost half (49 percent) of investors say are currently investing in ESG (socially and environmentally responsible) investment products, almost double the number in 2019 (26 percent).
Moreover, over a quarter of allocators are required to allocate to socially responsible products, also nearly double from the prior year. Much of this trend is being driven by investors outside of the US, with the majority (84 percent) of all investors in Europe either currently being (or expecting to be) required to invest in ESG products in the next two years.
As a result, socially responsible investing continues to prove to be a promising avenue for growth. However, the survey found, alternative managers are not keeping up with this demonstrated demand. Just one in five managers offer ESG products, which remains unchanged from 2019, and just under half of managers have been able to systematically include ESG risk factors in their investment process.
EY holds that whoever can mobilize and launch products in the ESG space will have a clear competitive advantage, since nearly all investors (88 percent) they spoke with say they currently ask managers how ESG is being incorporated into their investment decision-making.
Private equity funds are further than their hedge fund peers, since almost 64 percent of private equity managers currently have an ESG policy, while only half of hedge fund managers have one.
“Much of the initial historical progress we’ve seen from an ESG standpoint has been outside of the US, but with increased investor demand for these products and for their managers to be good corporate citizens, we believe this is a tipping point moment where all managers irrespective of geographic location will step up to address this issue,” said Natalie Deak Jaros, Co-Head of EY Americas Wealth & Asset Management (WAM), one of the authors of the report.