Europe’s Liquid Alternatives Market Is in Line for a Boost
December 7, 2020 — London
The industry is set to stabilize, but managers must adapt to asset allocators’ shifting preferences
The short-term outlook for liquid alternatives in Europe remains pessimistic, but the promise of uncorrelated returns is expected to boost demand over the medium term as investors diversify their portfolios, according to findings from the latest issue of The Cerulli Edge―Global Edition.
“Net new flows of liquid alternatives in Europe will likely be negative for a second consecutive year in 2020, although net new outflows are expected to moderate in the latter part of the year,” says Andrius Dovydavicius, a research analyst with the European institutional team at Cerulli Associates.
However, Cerulli believes that the greater transparency provided by liquid alternatives, falling fee levels, and the promise of uncorrelated returns will boost demand over the medium term as investors diversify their portfolios. In addition, the COVID-19 crisis will lead to greater dislocation in financial markets, creating opportunities for liquid alternative managers.
European liquid alternative assets under management stood at €356 billion (US$431 billion) at the end of September 2020, representing a 15% decrease from the beginning of the year. Net outflows exceeded €21 billion for the year, although withdrawals declined significantly to €1 billion during the third quarter.
Although, on average, liquid alternatives fared better than traditional investments during March’s bear market, financial markets’ quick recovery left liquid alternatives delivering weaker performance than traditional investments.
The industry’s overall interest in private assets is resulting in traction for liquid alternative funds focused on real assets. Cerulli expects this interest to remain strong, with demand likely from private banks and wealth management firms.
Cerulli is advising managers to reassess their liquid alternative product shelves, closing funds that have failed to deliver value for investors. Managers should also incorporate environmental, social, and governance (ESG) factors into their investment process. ESG liquid alternative funds have fared better than the overall liquid alternative industry.
“We believe that the sector will stabilize. However, managers will need to adapt to asset allocators’ shifting preferences to succeed,” says Dovydavicius.
Although European liquid alternative managers have enhanced their investor-relation capabilities since the Great Financial Crash and institutionalized their operational procedures, further adaption is needed. According the Alternative Investment Management Association, 53% of European managers are looking to optimize their use of digital tools and 22% are seeking to enhance the transparency and risk reporting of underlying funds.
In addition, managers should be prepared to offer fee concessions. Some 23% of European institutional investors expected to negotiate higher management or performance fee discounts for their hedge fund investments in 2019, according to Cerulli research.
- In Asia, investors are divided as to the merits of ESG investing. Nevertheless, managers are pushing such investments in various markets in the region, launching ESG-themed products to capitalize on the growing interest in sustainable investing strategies. But, says Cerulli, more evidence on consistent outperformance will be needed to overcome the skepticism of some investors.
- In the U.S., the economic disruption caused by the coronavirus pandemic will at worst create only a temporary headwind for alternatives demand and will at best stimulate opportunities that can be exploited in private markets, says Cerulli. Institutional investors in the country recognize that meeting their long-term investing goals via traditional asset classes will remain challenging.