Morningstar - Q2 2022 - 39

200
Starting values set at 100.
the one portfolio. Today, hedge funds are much
more likely to use a segregated " side-pocket "
arrangement for private assets, allowing investors
to choose the extent of the exposure instead
of the manager. Alternatively, many hedge funds
even provide a standalone fully drawn-down
private equity fund or a co-investment opportunity
for specific deals.
A key differentiator of public-market funds is
the capital-duration advantage. Having evergreen
capital, or to not have to go back to investors
to raise new funds, means they can be lifecycle
investors, participating from early pre-IPO
financing rounds to late maturity across multiple
business cycles. Being more hands-off and
not seeking board seats can be enticing for
company management. To fend off the competition,
top-tier private equity managers have been
seeking permanent capital pools. Most of these
management companies are now themselves
publicly listed; the switch from lumpy performance
fees to the more stable income from management
fees on this permanent capital is attractive
for both shareholders and general partners, who
are increasingly paid with stock options.
Investor expectations have also changed. As
decentralized platforms and pricing techniques
enter the mainstream, innovative liquidity
mechanisms may, in turn, attract a new class of
investor-a generation attuned to receiving
instant asset valuations and liquidity on
nonfinancial holdings. This democratization offers
a huge opportunity for firms to diversify their
investor base, a trait we've seen with specialpurpose
acquisition companies.
Much of these changes have been evolutionary
rather than revolutionary, but we can't shake a
feeling that we've seen this all before in the most
recent sector to become mainstream: liquid
alternatives (EXHIBIT 1 ).
Hedge Funds Grow Up
Hedge funds, a sector still dominated by
equity long/short offerings, demonstrated their
worth during the technology wreck of the
early 2000s. They delivered positive returns, while
equities declined by 44%. The collapse of
Long-Term Capital Management in 1998, an event
1 Year
Period
EXHIBIT 2
4
7
10
Postcrisis Growth Liquid alternatives funds went mainstream due to their
performance during the financial crisis.
Total Net Assets Alternative UCITS, 2009-17
Total Net Assets
EUR 400B
350.2
309.7
225.2
200
174.8
144.3
124.2
95.6
2009
2010
Source: Morningstar Direct.
2011
2012
2013
2014
2015
2016
2017
126.5
100
318.3
300
13
100
that first brought hedge funds to public attention,
was long forgotten. Still the purview of high-networth
individuals, hedge funds attracted
institutional investors for their low volatility and
seemingly uncorrelated returns. Assets grew
substantially between 2002 and 2008.
Index
Category
HFRX EH:Market Neutral Index
US Fund Equity Market Neutral
HFRX Event Driven Index
US Fund Event Driven
HFRX Macro: Active Trading Index
US Fund Macro Trading
HFRX Equity Hedge Index
US Fund Long-Short Equity
HFRX Macro: Systematic Diversified CTA
US Fund Systematic Trend
HFRX Hedge Fund Index
US Fund Multistrategy
Return
-0.50
empowers investors, who no longer face a
" take it or leave it " approach to gain access to
the sector.
2.04
To cater to the new institutional client base, the
hedge fund industry had to adjust its periodic
reporting and disclosure to high-net-worth
investors to the more regimented requirements of
trustees, boards, and other institutional investors.
Operational due-diligence experts became
ubiquitous, helping align fund operations to these
new requirements. This process of so-called
institutionalization, which was a comprehensive
overhaul to meet compliance and due-diligence
standards, was the start of making alternatives
mainstream.
The focus of these institutional investors on
transparency, independence, and conflicts
of interest has driven innovation and transparency
in private markets. New platforms facilitate
communication between investors and private
firms, and investor advisory committees
drive engagement and transparency in decisionmaking.
The independence of advisors
and administration still lags hedge funds but
is trending in the right direction.
2.46
3.81
3.55
2.90
3.55
4.51
0.12
0.71
2.07
-2% -1
The flood into private assets-Morgan Stanley
estimates that the inflows into private assets
over the past 45 years have risen by over
470 times-is requiring a similar transformation.
General partners still focus on finding deals,
but limited partners (the investors) now require
much stronger fund governance and oversight. The
growth in the number of private firms (between
7,000 and 30,000, depending on the data provider)
Regulations, Transparency, and Disclosure
Capital-market harmonization was a key pillar
in the convergence of the European Economic and
Monetary Union. The onerous UCITS regime,
introduced in 1985, was modified by UCITS III in
2003 as tighter risk-management considerations
allowed for an expansion in permissible
investments. Short-selling was not permitted, but
now derivatives providing the same return profile
were, all within products providing a minimum
of twice-monthly liquidity. This simplified
investment framework, a perception of safety,
and reduced administrative burden led to soaring
popularity of hedge-fund-like investments.
2.68
1
2
3
4
5
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