Time for the alternatives industry to write a new narrative

Read our article in the Cayman Financial Review Magazine, eversion 

Of the 20 biggest daily upswings in the S&P 500 since 1980, 10 have occurred in the last five years. Similarly, of the 20 biggest downswings, 13 have taken place in the last five years. 

Rarely have the markets been so wild. In fact, the last four years have been the most volatile in the history of markets. Price fluctuations of 4 per cent or more in intra-day sessions have occurred six times they did on average in the previous forty years.

Indeed a recent survey from CREATE-Research shows that markets are now in a prolonged era of heightened volatility until substantial progress is evident on the debt front in the US and Europe.

No wonder, pension funds worldwide have shown growing interest in alternative investments as a part of holistic solution to achieve uncorrelated absolute returns: positive investment outcomes irrespective of market conditions.

The 2008-09 bear market savagely exposed the scale of the funding crisis and damaged the reputations of many pension funds. Their focus on bonds and equities landed them with big deficits in their funding ratios. In response, they are scaling back on retirement benefits and raising the retirement age.

These measures are necessary but not sufficient. They also need decent returns on their investment portfolios. Even the most cautious public sector pension plans in the US and Europe are now making allocations to alternatives in general and hedge funds in particular. But their allocations come with some questions marks.

Two in three pension funds believe that high returns on hedge funds depend upon: fresh inflow of new talent, rapid innovation, as strategies go out of fashion and ability to commercialise the new strategies. There are doubts on each of these factors in the wake of the 2008 crash. Hence, those investing in hedge funds prefer to have high liquidity that permits them to move in and out, as and when market conditions change.

Nor are pension funds convinced that hedge funds managers can scale their business without sacrificing performance; or that regulation can prevent periodic blow ups. Although their allocations to alternatives have been rising, alternatives face a stiff competition from other – more manageable – sources of good returns. Six in every ten pension funds who are staying out of alternatives feel that they can meet their liabilities – requiring an average return of around 7 per cent on all their assets – without resorting to alternative investments.

For example, equity market increases of over 35 per cent in the last ten months indicate the challenges that alternative investments in general and hedge funds in particular face in an environment where investors display zero tolerance towards mediocrity.

Resolving the paradoxes and raising the bar

There is nothing new about these challenges. Hedge funds have weathered them during the period 2004-07. The most pressing challenge stems from the uniqueness of hedge funds. Like physics, hedge funds have no impossible frontiers.

But they have to grapple with three paradoxes. You need to have a critical mass of assets to attract new money, but without money, you can’t build the required mass. A sustainable hedge funds business needs scale, but size can be the enemy of high return. You need a rigorous investment process to attract institutional investors, but process can stifle creativity.

Doubtless, institutionalisation will professionalise the hedge fund industry beyond recognition by 2015. For example, pension funds want independent valuations based on transparent pricing models. They also want to receive valuation reports directly from the administrators, not via hedge funds managers. They want a fee structure that delivers value-for-money. Finally, they want all the regulatory and risk controls in place.

Things that made the hedge funds industry great – talent, individualism, enterprise – are the very things that will change. The challenge is to deliver uncorrelated returns in a changing landscape.

Cayman Alternative Investment Summit

It is this challenge that the Cayman Alternatives Investment Summit will address on 1-2 November. Its basic premise is that the industry is at an inflection point: A point where the future ceases to be different from the past. It’s a point at which the best way to predict the future is to invent it via a set of purpose actions that can create a more vibrant alternatives industry.

The speaker line up includes industry leaders like Peter Clarke, CEO, MAN Group, Harvey Pitt, former SEC Chairman, Matt Botein, Head of Alternatives at BlackRock, and some 40 other thought leaders. Each of them will address a unique challenge and suggest the way forward.

The emphasis will be on who needs to do what in order that the Alternatives Industry develops a new narrative on what it stands for and what it can deliver after a perfect storm. In their keynote addresses, President George W Bush and Sir Richard Branson are expected to set the tone and share their insights into actions that will create businesses of enduring value in the years to come.

The Summit will especially focus on three questions that will assist the industry in setting a clear agenda for this decade: how to create new opportunity sets for investors in the alternatives space, how to drive the alternatives into the mainstream space so that they become a big component in investors’ asset allocation and how to create an alignment of interest so as to create a win-win for investors and their managers alike.

We expect over 500 participants from numerous geographies who will also help to shape the industry narrative as it embarks on its next wave of growth.
 

cayai
 

Both authors are on the program committee of the Cayman Islands Alternative Investment Summit. 

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Amin Rajan

Working with prominent partners Amin Ragjan publishs acclaimed annual reports on prospective challenges and potential responses in the industry.  Amin also offers strategic advisory and coaching services to CEOs and CIOs in fund management as they grapple with unfolding industry dynamics. He has developed special expertise in emerging business models and their successful implementation. Since 2001, he has undertaken specialist advisory assignments for clients including Aviva Investors, Allianz Global Investors, Axa Investment Managers, BlackRock, Citigroup Asset Management, Credit Suisse Asset Management, Deutsche Asset Management, Invesco, JPMorgan Asset Management, M&G, Martin Currie Investment Management, Morgan Stanley Asset Management, Principal Global Investors, T. Rowe Price, and UBS Asset Management. He is a visiting professor at the Centre for Leadership Studies at Exeter University and a Fellow at Oxford University’s Said Business School. He is on the WHU Programme Advisory Board at Otto Beisheim School of Management in Koblenz, Germany.
 

Professor Amin Rajan 
CEO
CREATE-Research
The Haven
Vauxhall Lane
Southborough
Tunbridge Wells
Kent
TN4 0XD


T: +44 (0)1892 526 757
E: amin.rajan@create-research.co.uk            
W: www.create-research.co.uk

Anthony Cowell

Anthony is the Global Lead Engagement Partner on the audit of a multi-billion dollar investment management firm which focuses on non-traditional fixed income based strategies (such as high-yield bonds, leveraged loans, ABS, CDS and structured credit investments) and also several independent global private equity funds, funds of funds and hedge funds. In his role as Head of Markets and Head of Corporate Social Responsibility for KPMG in the Cayman Islands, his responsibilities include strategic planning, thought leadership and business development. Anthony was on the Editorial Board for KPMG’s Global Thought Leadership ‘Renewing the Promise’ in 2009 and in 2010 was the principal author of KPMG’s Global Thought Leadership report entitled “Transformation: The Future of Alternative Investments”.

Anthony co-authored KPMG's two part global thought leadership report in conjunction with AIMA. The first of these was the report "The value of the hedge fund industry to investors, markets, and the broader economy" which was then followed by a global hedge fund survey entitled "The evolution of an industry".
 

Anthony Cowell 
Partner
KPMG
Cayman Islands

T: +1 (345) 914 4338            
E: acowell@kpmg.ky            
W: www.kpmg.ky