The 15th annual EY Global Alternative Fund Survey finds an industry that has logged strong performance while struggling with DEI and ESG initiatives as institutional investor allocation activity has trended slightly upward.
The accounting firm surveyed 210 managers and 54 investors about a wide range of views on hedge fund industry trends including talent retention and a shift to retail offerings.
“Throughout 2021 the alternative funds industry has proven its ability to weather economic volatility and manage risk while producing returns that meet or exceed investor expectations,” officials wrote in the report. “And this performance has not been ignored. With more than half of investors surveyed saying that the value provided by alternative fund managers has improved relative to a few years ago, investors continue to embrace alternatives for diversification, risk mitigation, and returns.”
More than half of the 54 institutional investors surveyed reported that the value provided by their alternative managers had improved relative to a few years ago. Specifically, among hedge fund investors, 77% said these funds outperformed or met return expectations over the last 12 months. And investors saying that hedge funds outperformed over the past 12 months was nearly triple where it had been over the past three to five years.
According to E&Y, 2021 has seen hedge fund allocations reverse their downward trend of recent years, putting them on par with private equity. When asked about the percentage allocation to hedge funds, investors said on average 28%, while private equity makes up 27% of investor’s portfolios.
Officials said the industry is not where it was in 2018, when hedge fund allocations outpaced private equity by a two to one margin, and of course in 2020 private funds exceeded hedge fund allocations significantly.
As a sign of how private equity of course has outperformed hedge funds, private equity managers comprised represented half of the survey respondents but represented double the assets at $2.7 trillion. A 100% of survey respondents said private equity outperformed or met return expectations over the past year, compared with hedge funds — a figure that is unchanged from previous years.
In terms of longer-term trends, E&Y looked at ESG initiatives which are increasing in focus on the part of investors with 75% saying they have increased their focus on ESG in the last two to three years. Twenty percent of investors said they did not invest in a manager due to ESG concerns, while 19% said they had asked a firm to improve their ESG policies in some way.
Among managers, almost half (47%) of hedge fund firms said that their current ESG protocols are nascent, while only 28% of private equity managers said the same. Hedge fund investors, roughly 70%, said that they expect managers to provide formal ESG policies. The figure for private equity investors is similar at 69%.
E&Y officials point out that Europe remains ahead of other regions in adopting ESG mainly due to the first phase of the EU’s Sustainable Finance Disclosure Regulation (SFDR) taking effect. Managers doing business in Europe will need to begin disclosing their approach to incorporating ESG considerations into their investment processes.
Overall. private fund managers have grown in their aims of offering ESG products, with 31% saying they currently do, which is up from 19% in 2019. Another 6% are planning to offer ESG products, according to the survey.
DEI initiatives are still growing following a year of intense focus across the board among investment firms and their clients. Almost 50% of investors surveyed reported that managers’ DEI policies will impact their decision as to whether to invest, demonstrating that it’s imperative that managers have documented policies and initiatives in place.
The number of managers that previously did not have DEI policies in place, formal or informal, declined by 16% year over year, demonstrating that managers are taking action to make changes.
Looking at new product development, hedge fund managers notably have shifted even more into direct private investments. At the same time, many have expected more crypto investments to take off while only 7% of hedge funds currently invest in crypto-related assets.
When describing their expectations for exposure to crypto-related assets in the next one to two years, more than 20% of institutional investors and 26% of hedge fund managers stated that they expect to increase their exposure.
The largest managers were most likely to increase their exposure, with 36% of hedge fund managers with over $10 billion in AUM, and 32% of managers with $2 billion to $10 billion in AUM reporting that they expect to increase their crypto AUM.
Lastly, most investors say they still plan on doing virtual due diligence rather than in person due to the ongoing pandemic. But a minority (40%) expect to do in-person manager meetings this coming year.