Promising opportunities in alternative investments as industry nears $23tn by 2027

Let’s start with current conditions. How do you see a tougher macroeconomic environment for fund managers affecting the GP-LP relationship? 

It is challenging. In the last 36 months, we have seen the highest proportion of funds in the market for years. Private equity and real estate investors are citing asset valuations alongside rising interest rates as key challenges for return generation in the next 12 months, according to our survey data.

As a result of this environment, I think we’re going to see the pendulum swing a little, back to the allocators. In the past, the negotiating position has been much more firmly with fund managers. Fees and terms were not easily negotiable unless you were a very large allocator. As long as returns were good, many investors were comfortable with that.

Our LP and capital allocators solutions business, Colmore, has launched a Term Intelligence offering this year, as investors have told us they’d like more data to get a better sense of the market rate when it comes to fees and terms. There is now an opportunity to have a more open, transparent conversation around that. 

What do you consider the most promising opportunities in alternatives? 

One exciting trend we’re seeing is the democratization of private markets. Private wealth – or let's call it the non-institutional capital segment – is increasingly moving into alternatives to access attractive risk-adjusted returns and achieve greater diversification. The wealth management channel represents a multi-trillion-dollar opportunity, with less than 5% allocated to alternative investments today. 

Meanwhile, structural trends that have benefited our industry since Preqin’s founding in 2003 are very much continuing: the strong risk-adjusted and absolute returns I’ve mentioned, diversification, and reduced portfolio volatility. On promising opportunities, one asset class consistently coming up across the globe is private debt. The floating-rate nature of some of its instruments provides an inflation hedge, and as we’ve seen in the last few months, recent bank failures and difficulties have made access to credit even more challenging. Private debt funds are well-positioned to step in and fill the void caused by banks retrenching since the Global Financial Crisis. 

Within private credit, various strategies are looking promising, but the one that stands out when looking at investor interest right now is distressed debt. We haven't seen a distressed cycle in Europe or the US for some time. What we have seen is central banks and governments pouring a lot of capital into the markets, and as the economic outlook worsens, investors are expecting that distressed cycle to kick off. 

How do you expect the alternatives industry to evolve as it grows and becomes more mature? 

We’re seeing the industry consolidating, and that's coming across clearly in the latest fundraising numbers: more capital is being raised by fewer funds. We all know about mega funds being raised across a multitude of strategies by the industry giants and there’s also a whole host of firms that have grown into $50–100bn+ assets under management (AUM) businesses. 

Why is this happening now, and will it continue? There’s a flight to safety, and in this case, it means LPs going to institutions they know and trust, those that have established a track record of success. These are institutions that have robust processes and systems in place, and that is exactly what is coming through in the current fundraising statistics.

On top of that, there is M&A: large fund managers acquiring stakes in other GPs, alternative asset management firms acquiring insurance businesses to secure more longevity of capital. We’re seeing more of the larger firms branching out into other asset classes to diversify their own business models and build their AUM.

Companies staying private for longer is a trend that will continue, fueling further growth in our industry. Right now, it's partly down to the exit environment on the public side being restricted. We haven’t seen meaningful IPO activity in the US or Europe for a while, and I don't think that's going to change much this year. 

I also see ESG becoming an increasingly critical element in investor due diligence, reporting, and GP risk management. On the diversity, equity, and inclusion (DEI) front, our industry has made some progress, but there’s more we can do to improve. Setting meaningful targets, collecting data, measuring our impact, and holding ourselves accountable are key priorities if we are to move the needle.

What do you see as potential threats to the growth of alternative assets? 

For more than a decade, we’ve been in a world where in most of the developed markets, inflation was very low. Interest rates were effectively zero, and there was an expected return linked to alternative assets. Today, we're in a world where inflation is still very high, putting pressure on investments. We’re also in a world where financing costs are very high and still increasing, and access to credit is restricted. 

That means the value creation levers have gotten quite a bit more difficult. What kind of return can investors expect from the same fund managers? The overall equation of expected return has shifted, so we might see a situation where some investors might decide that if you can get a fixed-income instrument backed by the US government yielding several percentage points instead of near-zero, why would you take on risk in certain pockets of the private markets for a very small illiquidity premium? 

Fund managers will need to continue to show that they can pick good assets, as well as operationally improve those assets. It's not a leverage play or multiple arbitrages, it's an operational improvement play. 

Christoph, earlier you mentioned the growing private wealth segment. How else do you expect the investor universe to change in the next 20 years? 

I think it will become much more diverse than it has been. We are seeing the ultra-high-net-worth demographic coming in and investing through intermediaries that can support that, be it private bank channels or technology platforms, and I think we're going to see more of that. But for that to happen, we need to have more sophistication and more education, which is where Preqin comes in. 

We will need more streamlined technological solutions – which are starting to emerge – to help with that process, because for fund managers, they can't have one-on-one negotiations with thousands of retail investors. Additionally, not every retail investor will go through a consolidator, like a private bank. There's a bit of infrastructure building that needs to happen, but it's all moving in the right direction. 

We’re seeing large fund managers building huge teams to work with financial advisors, which will further open that market up. We’re already seeing technology players who are facilitating a more seamless way of allocating to alternatives. 

And on top of that, there are still many institutional investors that have not actively invested in all the interesting asset classes. And that's also changing in regions such as APAC. There’s a question mark as to what that means when we talk about fees and terms: how effectively can the non-institutional capital negotiate these? Are they going to accept the terms they receive to get that access?

Turning to geographies, which regions do you think will offer the most opportunities in the next 20 years?

I think the interesting thing about alternatives from today’s vantage point is that all the key markets are still attractive. The US has great depth and breadth and is very mature already. But we still see plenty of opportunities there, and 20 years from now I suspect we'll still see the US as a core market. In Latin America, we expect room for greater allocation to alternatives, and opportunities to fundraise from pension funds and private wealth.

In 20 years, many of the APAC markets will likely have caught up with Europe and the US in some ways. Greater China is a huge market already. Japan is looking attractive; stock markets there are the strongest they’ve been in a long time with inflation and interest rates not weighing on the economy as much as elsewhere in the world. 

India, where we have a local presence, is a very interesting market. It's poised to be one of, if not the largest, economy in the world at some point. And with that comes an evolution in the alternatives market. 

The Middle East has a lot of capital to invest; they’re investing significant sums locally to diversify their economies and develop even more dynamic, sustainable economies for the future. 

In Europe, there are a couple of key questions for investors on issues like market integration, and how the UK’s role could change being outside the EU. There’s also the need to manage Europe’s energy transition effectively. I would also point to the importance of innovation. So much comes out of the US, but now there’s a lot of focus in countries like Germany and the UK to ensure we build a more robust start-up ecosystem. Europe has its challenges but also huge opportunities as we look 20 years out, and private capital will be crucial in supporting this, helping fund the energy transition, and unlock innovation potential. 

When you look to the future, what excites you the most about the alternatives industry?

I think there’s a big opportunity in data, data management, and technology to support the workflows of all the incredibly smart people working hard in this industry to grow capital for generations of beneficiaries. The market has been opaque, which is why when Preqin was founded, our mission was to provide transparency. Data availability and comparability has been a challenge for investors. On the back of that, technology adoption has been a bit slower. The exciting thing for me is helping the industry to operate much more efficiently than has been possible in the past. I believe this will lead to even better capital allocation decisions, and ultimately, even better risk adjusted returns.
 

*Forecast for alternative assets (including hedge funds) reaching $23.3tn in AUM by the end of 2027 – up from $13.7tn at the end of 2021 (growth of 70.7%) – is based on Preqin’s 2022 Future of Alternatives report, exclusively for Insights+ subscribers. Watch out for our Future of Alternatives Update for the latest forecasts, launching later this year.

_{The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin providing the information in this content accepts no liability for any decisions taken in relation to the above.}