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Institutional investors transforming the alternative investment industry

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A dramatic shift in the balance of power has given institutional investors the upper hand in the alternative investment industry, according to KPMG’s recent report “Transformation: The Future of Alternative Investments”.

Their demands for institutional grade controls, increased transparency, liquidity and flexible product strategies are driving fundamental changes in the very warp and weft of the industry – business models, fee arrangements, servicing agreements, for example – and are affecting all players.
 
Anthony Cowell, partner at KPMG in the Cayman Islands and principle author of the report, says: “Historically, anyone considering an investment in alternatives had to invest on the manager’s terms. Today, the picture of the industry has been turned on its head; it’s now one in which investors are firmly in the driving seat and, fundamentally, investors want to see managers interests more closely aligned with their own.”
 
This picture is not likely to change anytime soon. More than 50 per cent of institutional investors surveyed said they intend to increase their allocations to alternatives in the next three years; some anticipate an allocation of over ten per cent of total assets. Managers, for their part, are not blind to this change in dynamic with 70 per cent attesting that client service is their top priority after performance.

Investor influence has driven the creation of a new breed of manager. From a legacy of boutiques (five people with one strategy in an apartment in Greenwich or Mayfair), to super boutiques (increased global reach and size), a new breed of manager is emerging – the entrepreneurial-institutional manager. They are a step change along the path of institutionalisation. They are more formalised and offer clients multiple products through multiple distribution channels. Despite their size, their mission remains the generation of performance as opposed to simply gathering assets.
 
Investor allocation decisions are also shaping the alternatives landscape. Fund of funds did not have a good market crisis, say their investors. As a result, larger institutional investors are moving to an allocation model with a clear trend in favour of direct investment and managed account platforms, the latter for reasons of security, liquidity and transparency. At the same time, allocations to fund of funds are falling.

Larger fund of fund managers with the resources to expand into managed accounts, diversify their offerings in other ways, and use their brand name to attract investment will survive. Many smaller players, however, are unlikely to be able to compete and the result may be a wave of M&A activity.
 
Surprisingly, while regulation has been widely promoted as a way to protect investors, the report finds that the majority are against it. Reasons cited include the belief that regulation will not produce any tangible benefits, it will add costs and bureaucratic burden, it will stall the industry’s engine of creativity and it will limit choice. In addition, 81 per cent of institutional investors indicated that domiciliation makes little difference with regard to allocation decisions.
 
“There’s an interesting distinction here,” says Cowell. “While investors are clearly looking for products with increased transparency and liquidity, they do not seem to be demanding regulated products. Nor are they particularly concerned with the question of domicile, which runs counter to how much attention the onshore/offshore debate has attracted lately. Managers would therefore, be wise to maintain their offshore fund range for their bedrock investors even while EU domiciles develop complimentary structures onshore.”

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