Luxembourg, 19 November 2020. Despite extreme levels of market volatility, increased trading volumes and disruption to society due to COVID-19, alternative fund managers persevered, and even exceeded, performance expectations from investors. Despite this, managers continue to fall short in important areas including environmental, social and governance (ESG) products and diversity and inclusion, according to the 2020 EY Global Alternative Fund Survey,
The 14th annual survey found that total allocations to alternative investments remain relatively unchanged, however, the competition between asset classes continues to intensify. Following a multi-year trend, allocations to hedge funds shrunk again to just 23% in 2020, compared to 33% in 2019 and 40% in 2018. Investments in private equity and venture capital remained stable at 26%, while investments in private credit increased from 5% to 11% as many market participants anticipate COVID-19 initiating a credit cycle that will create opportunities for these managers.
A shift in alternative products is not the only change this year. 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%) surveyed believing the impact of COVID-19, and the related market volatility, will increase investor interest in active management. To note, nearly one-third (30%) of investors responded that the COVID-19 related market volatility has in fact increased their interest in actively managed alternative investments.
Alternative funds demonstrated resilience as they dealt with, and continue to grapple with, the fallout from the COVID-19 pandemic, with technology as a significant driver of this success.
The alternative funds 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 expectations, with 58% of hedge fund investors and the majority (81%) 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.
Operationally, the alternative funds industry is expecting to return to business as usual post-pandemic, even though it was successful moving to remote work. Despite this rosy outlook, alternative fund managers still expect that one-third (32%) of back-office and middle-office professionals will work remotely after conditions normalize and 28% of front-office professionals will as well. This speaks to the efficiency and resiliency that each group has demonstrated, but also to the evolving expectations of employees wishing for greater flexibility in their work locations.
COVID-19 has accelerated many of the digital trends that we’ve seen over the past several years, which have become critically important for alternative managers. Investors are reasonably satisfied with their managers’ efforts to embrace technology and data. Hedge funds in particular were reviewed favorably, as over half (53%) of investors surveyed felt that the hedge fund industry was ahead of the curve from a technology perspective relative to other financial services. When considering credit and private equity, this number drops to 30% and 28% respectively. For example, one-quarter (24%) of hedge fund managers are using, or plan to use, advanced data to predict investor behavior, and one-third (35%) are doing so to analyze their own internal operations.
Despite these advancements, there is room for improvement when it comes to outsourcing certain functions, as no fund managers reported entirely automated services. Similar to advanced technologies, hedge funds are further along the automation journey in all key functions, including fund accounting, treasury and valuation.
“COVID-19 has served as a catalyst in the alternatives industry, both in terms of how firms use technology to facilitate remote working, but also how they use technology to create efficient, modern systems that enable productivity,” said Michael Ferguson, Wealth and Asset Management Leader at EY Luxembourg. “Hedge funds are the clear frontrunners as they were early adopters of outsourcing and continue to leverage next-generation tools such as machine learning, robotics and blockchain technology to keep up with their evolving, complex business operations.”
ESG Expectations
Allocators are increasingly focused on ESG products and socially responsible investing, but also wish to partner with managers who prioritize their own internal ESG policies. As the survey shows, almost half (49%) of investors are currently investing in ESG products, which is almost double the number of investors including ESG products in their portfolios in 2019 (26%). Further, over a quarter of allocators are required to allocate to socially responsible products, nearly double from the prior year. Much of this trend is being driven by investors outside of the U.S. with the majority (84%) of all investors in Europe either currently 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, as the survey shows, alternative managers are not keeping up with the 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 into their investment process. Those who can mobilize and launch products in the ESG space will have a competitive advantage, as nearly all investors (88%) ask managers how ESG is incorporated into their investment decision-making.
Separate from products, nearly three-quarters (70%) of investors reported that an alternative manager’s internal ESG policy is critically important when deciding whether to invest. This is a tremendous increase from 2019, with just 27% reporting this as critically important. Private equity funds are further than their hedge fund peers as almost 64% of private equity managers currently have an ESG policy, while only half of hedge fund managers have one.
“Most of the progress we’ve seen from an ESG standpoint has been outside of the U.S., but with increased investor demand for these products and for their managers to be good corporate citizens, we expect this to change,” said Dietmar Klos, Real Estate Leader at EY Luxembourg. “We are seeing some response to these expectations, however traditional hedge fund strategies have faced more challenges when embracing ESG investing. With the emergence of ESG frameworks and scoring, as well as broader inclusion of ESG risks into the investing process, there are opportunities for hedge funds to prove they are capable of providing investors with products that meet their needs in the future.”
Talent management: a top concern for alternative fund managers
Despite both prioritizing talent management, hedge funds and private equity firms have different approaches. Both say improving productivity and engagement is a top priority with 42% and 31% ranking this as the number one priority, respectively. From here, priorities diverge.
Private equity firms, largely because the success of these companies depends on new ideas and perspectives, have prioritized increasing gender representation, with more than half (56%) reporting this as a top three priority, and one quarter (24%) placing it as a top priority. Additionally, more than half (52%) of managers reported increasing ethnic minority representation as a top three priority. Implementing strategies to increase gender and ethnic diversity were ranked lower on hedge fund managers’ list of priorities, with 26% of managers reporting increasing gender representation and 23% reporting increasing ethnic minority representation as a top three priority.
Investors, on the other hand, are keenly aware of the need for more diversity. Nearly all investors note that a manager’s D&I policies play a role in their decision to invest. This is particularly important to attract capital from outside the U.S., as nearly all investors outside the U.S. note that D&I policies play a critical role in the investment decision.
While awareness is important to achieving more diversity, there’s significant room for growth seeing as the majority of alternative fund managers (68%) have informal, or no, D&I policies and when comparing hedge funds and private equity firms, 33% and 26% have no formal plan, respectively. Almost two out of three managers (62%) promote awareness and provide training on bias and inclusion (59%) as part of their D&I initiatives. From there, there are large drop-offs as a minority of managers reported sponsoring diversity groups, interview training, setting diversity targets and other initiatives. Additionally, front-office roles continue to have a significant lack of diversity. More than half of hedge fund managers (56%) and 39% of private equity firms have less than 10% of women in front-office positions, which is almost entirely unchanged from 2019 (53% for hedge funds and 35% for private equity).
An ethnically diverse organization is also critical to an organization’s success and an area of focus for investors. Compared to gender diversity, underrepresented minorities make up an even smaller percentage of alternative fund managers’ workforces. Two-thirds of hedge fund managers (65%) and more than three out of four (78%) private equity firms reported less than 10% of front-office employees that are underrepresented minorities. The back office proves to be slightly further along than the front office for both hedge fund and private equity managers, but the vast majority of managers indicated they have back-office teams with 30% or less minority representation.
“There are a number of reasons that diversity at alternative fund managers is critical, but investor behavior and expectations is near the top of the list,” said Laurent Capolaghi, EY Luxembourg Private Equity Leader. “As this year’s survey shows, most investors feel that their organizations are more diverse than their fund managers’, and a vast majority (96%) of investors want to allocate more to female- and minority-led firms. Now is the time for alternative fund managers to step up and hire a more diverse workforce. The experiences and knowledge from these individuals will prove to be fruitful in generating new ideas that ultimately benefit investors.”
The complete survey is available at:
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