An increasing number of institutional and alternative asset managers are switching to new asset classes. Many are moving into loan investments, including private debt and direct lending (purchasing/issuing loans to small-to-medium-sized enterprises [SMEs] that are excluded from traditional bank financing). Why the change of course?
Since the financial crisis, active funds have faced rising competition from passive investment strategies, with many struggling to outperform benchmarks. In 2016, one in three large cap managers wasn’t able to beat the S&P 500. 1 Although performance picked up the following year, it stayed relatively low with only 43 percent exceeding passive peers. 2 This is driving active managers to look for new investment avenues.
Total hedge fund assets hit a record $3.23 trillion in 2018 3, but managers who were once able to identify interesting investment opportunities now find themselves crowded out of those trades, which is pushing firms to pursue new investment strategies.
For the $2.83 trillion private equity industry, client satisfaction is high, with 93 percent of investors telling data provider Preqin that returns in 2017 had met or exceeded their expectations. Nonetheless, the current private equity market runs the risk of overheating 4, so firms are increasingly moving away from buyouts and investing in different asset classes.
The reluctance of banks to provide loans, due to low rates and regulations such as Basel III, which assigns SME loans a higher risk rating, is also driving investment in loan funds. Local regulators in France and Italy have backed measures aimed at loosening SME dependency on bank financing by easing limitations that had previously prevented - or heavily restricted - non-banks from participating in direct lending activities. Pan-EU initiatives such as the European Long-Term Investment Fund (ELTIF) have also contributed to the trend by creating an augmented regulatory structure for asset managers that are authorized under AIFMD to originate loans across the EU.
Sources:
1 CNBC (April 12, 2017) Bad times for asset managers: Almost none have beaten the market over the past 15 years
2 Mercer Capital (2018) Value Focus: Asset Management Industry
3 Hedge Fund Research (July 19, 2018) Hedge fund assets eclipse record level for eighth consecutive quarter despite mixed capital flows
4 PE News (June 4, 2018) Half of investors think the buyout market is overheating – Coller