Investors favour real estate, private equity and hedge funds

THE real estate sector may deliver better returns than bonds, but investors should be patient and selective when looking at new property allocations, according to the Global Alternatives Survey 2016, published by Willis Towers Watson, a leading global advisory and broking and solutions company headquartered in London.

The researchers believe the real estate markets in countries such as the US and the UK are nearing their peak. “This means one needs to be increasingly cautious of higher risk property strategies, particularly those using high levels of debt. The continental European market appears further away from the peak cycle.
Despite its economic issues, with low or negative interest rates, property looks reasonably supported as long as prolonged deflation can be avoided,” says the report.

The report, released on July 11, says the sector has seen healthy rental growth in many markets. The outperformance was strongly driven by investors’ desire for attractive yields in a low or negative bond yield environment.

“In many ways — the double-digit returns, transaction volumes at multi-year highs, yields reaching multi-year lows, debt costs at ever lower levels on higher loan-to-value terms and speculative development starting to re-emerge — it feels like 2007,” says the report.

“We have also seen a growing trend of private real estate funds acquiring listed property companies, a trend we last saw emerge at the previous peak in markets. That being said, unlike 2007, the property yield spread relative to long-term government bonds shows a healthy spread, which provides some investor comfort.”

The report points out that although emerging market property sectors have been weak and near-term catalysts remain uncertain, there could be attractive entry points for long-term investment in certain sectors.

“We believe future demand for long lease property strategy is likely to persist as long as bond yields remain low. The ability to source attractive assets, however, is becoming more difficult, so subscription queues for such strategies may well increase,” it says.

There is also growing interest in alternative property sectors around the world, such as healthcare, storage and student assets. The private rented sector (properties built to rent out to various types of households, including students and lower-income families) in the UK is also becoming popular with investors.

“Strategically, the addition of these alternative sectors generally helps diversify against the cyclicality of offices, which can often be a disproportional contributor to risk in portfolios.”

Challenging times for PE and hedge funds

The report also says private equity (PE) and hedge funds may continue to face downward pressure and capital withdrawal due to high fees. For hedge funds, the recent disappointing returns have led to some redemption pressure, but this is healthy for the industry.

While there have been performance headwinds for hedge funds, the report says the need to diversify away from traditional equities is the strongest it has been in several years. Hedge funds and alternative beta strategies, which can be broadly categorised as liquid alternatives, are uniquely equipped to deliver returns while helping investors mitigate downside risks.

“We anticipate that some capital will be withdrawn from the industry, especially the hedge fund of funds industry, given the high fees traditionally charged by these organisations. But overall, we continue to see value to be had if done correctly, and we are advising our clients to increase their allocations generally. Industry-wise, we anticipate continued growth in alternative beta strategies and assets, perhaps offsetting any redemption from alpha-seeking managers who have struggled to perform.

“There are diversifying return drivers that are best sourced outside of the traditional hedge fund structure and for fees that are much less — commonly referred to as alternative beta strategies and include strategies such as reinsurance, carry, value and merger arbitrage.

“However, given the rapid growth in this emerging space, there is some risk of crowding and investors who do not fully understand the risks of investing here should work with an adviser or outsource.”

The PE fund sector has seen healthy growth. “Fundraising in PE is buoyant off the heels of three years of very strong distributions and with investors looking for alpha as other asset classes of late have not delivered excess returns.

“Going forward, we expect to see more development in customised portfolios for investors, especially from the larger managers, who have created asset management businesses instead of pure-play private equity ones.”

Willis Towers Watson expects continued downward pressure on fees in the PE industry over the long term. Part of that pressure will be from the ongoing disintermediation story in PE, with large asset owners doing deals themselves or at the very least, investing in funds directly without the need of a fund of funds.

The survey covers 10 asset classes and ranks the largest alternative investment managers. According to the survey’s results, the top 100 alternative asset managers (ranked by total assets under management) managed US$3.6 trillion on behalf of investors in 2015, a marginal increase of 3% from US$3.5 trillion in 2014.

The largest block of alternative assets is managed in direct real estate funds, followed by direct hedge funds, direct private equity funds, private equity fund of funds, fund of hedge funds, illiquid credit and direct infrastructure funds. There were no real assets, direct commodities or insurance-linked investment fund managers among the top 100.

Pension funds were the largest investors in alternative assets (34%) among the top 100 alternative asset managers, followed by wealth managers, insurance companies, sovereign wealth funds, endowments and foundations, fund of funds and banks. In terms of where the assets are invested, North America (50%) accounts for the largest amount of investments, followed by Europe (37%) and Asia-Pacific (8%).

This article first appeared in Personal Wealth, a pullout of The Edge Malaysia Weekly, on July 18, 2016. Subscribe here for your personal copy.