Investment advisers have laid the groundwork for further growth in the alternative investment market
• Investment advisers are increasingly focusing on alternatives, in response to strong client demand
• Most consultants offer advice on the whole spectrum of alternatives, with similar structures in terms of staff and processes
• Qualitative research on alternatives is key, but there is a growing role for quantitative analysis
• Advisers are concerned about growing dry powder and high valuations in the sector
The challenges of investing in alternative assets are well known, from liquidity to mark-to-market issues. One that is perhaps less talked about is how to choose advice on alternative assets. Pension funds have occasionally lamented the quality of investment advice on alternative assets by both large and small consultants.
In the UK, consultants are in the spotlight, with regulators investigating their activities to assess whether they are offering value for money to their clients. The quality of advice in this complex and rapidly changing area will separate the winners from the losers in the relatively narrow investment advice sector.
Large, established players such as Aon, Mercer and Willis Towers Watson – sometimes referred to as the ‘big three’ investment consultants – have similar arrangements covering the spectrum of alternatives, with teams of analysts specialising in different sub-sectors. The same goes for smaller competitors such as US-based Cambridge Associates and P-Solve, the institutional investment and actuarial consulting division of the River & Mercantile Group. However, there are some important differences in the organisational structures and different philosophies that underpin the advisory activities of these firms.
At Aon, alternatives are split into real estate, private equity and liquid alternatives, according to Matthew Towsey, principal, who sits on the liquid alternatives team.
This team focuses on hedge funds, risk parity and alternative risk-premia strategies. There are 16 analysts within the private equity team, which is primarily based in the US. The real estate team has 12 analysts, four of whom are based in the UK. Towsey’s liquid alternatives team has five analysts in the UK and 10 in the US.
Aon also has a team of 29 people based in Bangalore, India, providing support, particularly around data analysis. A team of six, based in Singapore and known as the ‘innovation’ team, is tasked with providing ideas on how to improve Aon’s advice capabilities. Furthermore, the firm has a 21-person team specialising in operational due diligence on various asset classes.
Recently, Aon acquired the Townsend Group, a US-based specialist adviser on real estate and real assets. Once the group is integrated, the firm will have more than 100 investment researchers dedicated to illiquid strategies. “That gives you an idea of Aon’s commitment to illiquid assets and of where we see value for our clients and growth in their portfolios,” says Oliver Hamilton, principal in the real estate team.
Mercer has over 120 manager researchers worldwide, working on all asset classes – not just alternatives. The firm has split its advice capabilities in alternatives into two main areas: liquid alternatives and private markets. The private markets team has over 30 investment professionals operating out of nine offices in North America, Europe and Asia-Pacific. The firm is well known for its global investment manager database (GIMD), a repository of data on strategies that is maintained by asset managers themselves. There are more than 5,700 managers on the database, which covers equities, bonds, real estate and alternatives.
Mercer’s liquid alternatives team evaluates hedge funds, multi-asset funds including diversified growth (DGF) strategies and commodities and insurance-linked securities (ILS). The rationale for splitting advice in two areas – liquid and non-liquid alternatives - is straightforward. Mercer’s analysts use a similar framework when making the final decisions on how to rate strategies, whether liquid or illiquid.
Robert Howie, principal at the firm’s hedge fund boutique, says: “We score managers on four main areas: idea generation, portfolio construction, implementation and business management. To get our top rating, managers usually need to score highly in each area, especially on idea generation.”
Willis Towers Watson
The manager-research team of Willis Towers Watson has over 100 analysts based around the world. Luba Nikulina, global head of manager research, explains that the firm is gradually abandoning the distinction between traditional and alternative assets. Analysts retain their specialist skills, but they are encouraged to get exposure to as many asset classes as possible within the main areas of equities, bonds and real estate.
Nikulina says: “When I joined, I was a very narrow-minded private-equity specialist. Although it’s incredibly important that an analyst has deep knowledge of their asset class, it was only when I looked at public markets, that I actually understood how to invest in private equity better.” She adds that if consultants have the same exposure to options as clients, they will make better-informed decisions not only on an absolute basis but also relative to what else is available in the investment universe. “Of course, you need a very large team to do that.”
At Cambridge Associates, 150 specialists are focused on building customised alternative asset portfolios of hedge funds, private real assets and private credit. The figures represent half of the firm’s analysts and client-facing staff. There are also 15 experts in operational due diligence conducting separate research. The firm has built a proprietary database of alternative managers and calculated several well-recognised benchmarks for the sector. Cambridge Associates’ teams held around 4,500 face-to-face meetings with alternative fund managers over the course of 2017, according to a spokesperson for the firm.
P-Solve, the consulting arm of River & Mercantile, has more than 50 staff focused on asset class and manager research. There is no explicit strategy for alternative assets, according to Ajeet Manjrekar, the firm’s co-head. He explains: “The research priorities for our dedicated research team are dictated by our macro-economic and asset class views. This avoids spending hours researching strategies and managers that may not be used by our clients. Our rigorous process tends to see us focus on a small number of alternative assets where we can ensure a deep understanding of the opportunity, strategy and manager from an investment and operational due diligence perspective. In addition, we will work with managers to build the right fund for our clients if no existing fund exists.”
Putting it into practice
Analysing alternative strategies involves a great deal of qualitative analysis, requiring face-to-face meetings with managers, which is very time-consuming. In most cases, analysts spend between 100 and 200 hours evaluating each strategy.
Mercer’s Howie says: “Our rating process consists of following a fund over a period, usually of about 18 months, but we do also rate start-up funds. We do on-site visits that usually last for half a day, during which we meet not only senior management but also portfolio managers. Their experience is very important. We look for an edge in their process.
“Visits are preceded by a period of pre-reading, multiple calls, and writing up of notes. The notes are peer-reviewed and reviewed by a ratings committee. If you sum up the hours spent on each strategy, it’s a pretty large number.”
Increasingly, however, quantitative analysis is used to enhance the process. Aon’s Towsey says: “One of the improvements we’ve made over the years is using data to a greater extent. Five years ago, we started working on how to assess managers across asset classes on a quantitative basis. For managers we don’t already have a close relationship with, we now have a way of taking performance and other data from them, ranking them in peer groups and coming up with quantitative ratings. It’s a strong first glance at a manager, which will tell us whether the manager should be investigated further.
“We’ve made huge strides in data gathering and processing over the past five years, also thanks to the dedicated team based in Bangalore. They help us with reviewing managers as well as running the risk models we use. Every quarter we also discuss ways to improve our processes with inputs from the innovation team based in Singapore,” adds Towsey.
A similar thing is happening at Willis Towers Watson. Nikulina says: “A lot of analytical work is done at the start of the process. We have a separate team that helps us with quantitative analysis on strategies. They help us ask better questions when we go into meetings with managers. This is where we start understanding how managers take investment decisions and how to best engage with them”.
Design and build
Consultants often helpasset managers to design products. Nikulina says: “There is also a significant element where we usually attempt to improve what is being offered to our clients in terms of structure and fees. We spend quite a bit of time negotiating, and increasingly we will find ourselves asking managers to improve on their products to offer our clients something unique that suits them. Often, what the asset management industry offers is driven more by commercial interests rather than a deep understanding of the demands of the client base.”
Aon’s Hamilton adds: “In the real-assets sector, it is probably fair to say that it is harder to work with managers on fund design. However, it does happen and last year our real estate team worked with a number of managers to launch products which were tailored to meet client needs from a risk-and-return perspective, and to structure attractive fee deals. The difficulty we have is we need to balance between making sure we find the right manager we’re comfortable with, versus having a deliverable we can put in front of the client and proactively working with managers can help with that. That’s a tension we always have, because the funds are closed-end, and fund launches from managers may come every three or four years.
“In addition, whenever we can, we work with managers during the early stages of fundraising. That’s when you can make changes to documentation and agree on reductions of fee levels with them,” adds Hamilton.
Consultants agree that their clients have become more sophisticated in the way they invest in alternative assets. At the same time, transparency in the sector has improved. These are a generally positive developments. They are counterveiled by a challenging market environment that is making it harder to provide proper advice.