Investors Widely Prefer Small Private Equity And Hedge Funds

At a time when investors and fund managers have struggled to find returns, some corners of the alternative asset space have held up better than other areas of the markets, like public equities. As a result, it should be no surprise that institutional investors are planning to boost their allocations to alternative assets. However, one interesting finding from a recent survey is that smaller hedge funds and private equity funds with less than $250 million in assets under management are in demand.

BRAZIL - 2022/10/05: In this photo illustration, the SSC Technologies Holdings logo is seen ... [+] displayed on a smartphone.SOPA Images/LightRocket via Getty Images In its 2023 LP Survey conducted in partnership with Private Equity Wire, SS&C Intralinks asked limited partners the kinds of questions general partners want to be answered. One of the findings was that 70% of the investors surveyed expect to increase their allocations to alternative investments in the next 12 months. A little over 29% said they would not. More than 32% said they plan to boost their allocations by at least 10%. The next popular percentage increase was 3% to 5% with 14% of respondents, followed by 5% to 9% at 12% of investors. Preqin's findings in a separate study mirror those found by SS&C Intralinks. The firm found that assets under management across all alternative asset classes are likely to rise. Between 2015 and the end of 2021, AUMs across all alternative asset classes rose at a compound annual growth rate of 10.7%.

At the end of 2015, assets under management stood at $7.23 trillion, rising to $13.32 trillion at the end of 2021. Preqin projects AUM growth to accelerate to 11.7%, carrying alternative asset AUM to $23 trillion in 2026. Smaller fund managers with less than $250m AUM are in demand

Limited partners can't get enough of alternative assets, as demonstrated by the nearly 18% of respondents with over $5 billion in current allocations to alternatives. However, the firm also learned that smaller funds are in demand, as more than 44% of investors prefer managers with less than $250 million in assets under management. This finding is interesting in light of reports from other sources, like fund administrator Citco, that indicate larger fund managers have generally outperformed smaller ones.

The fund sizes that were most in demand over the last 12 months were $100 million to $500 million in assets under management and funds with at least $1 billion under management. According to SS&C Intralinks, 66% of investors were seeking funds within one of those two size groups -- split evenly with 33% of investors each. The survey found that 18% of investors were looking for funds with over $5 billion in assets under management, only slightly more than the 16% seeking funds with less than $100 million under management.

Looking to the next 12 months, the preferences based on fund sizes are similar. SS&C 38% of investors are seeking funds with over $1 billion in assets under management, while 36% want to invest in funds with $100 million to $500 million. Only 15% of investors plan to favor funds with less than $100 million under management, followed by 11% of investors planning to target funds with over $5 billion.

Emerging managers

Of course, emerging managers can play critical roles in asset management, and some investors will actually be favoring emerging managers in the coming year. The report found that 33% of investors will be favoring emerging managers in private equity over the next 12 months. Meanwhile, 23% of investors will favor emerging hedge fund managers, while 21% will favor emerging managers in venture capital.

The firm found that the primary reason for limited partners to allocate to emerging managers is because they want exposure to certain niche strategies. In fact, 29% of respondents cited exposure to niche strategies as their top reason for favoring emerging managers.

Additionally, 28% favor emerging managers due to attractive return potential, while 22% cited a desire to access new talent as their top reason to allocate to emerging managers. Other incentives included increased portfolio diversification and the possibility that a general partner will negotiate better fees.

However, despite the apparent appetite for emerging managers, one expert told SS&C Intralinks that those emerging managers will probably have the greatest difficulties raising capital because investors are having to make difficult choices about where to invest. As a result, when forced to choose between allocating to new, emerging talent or re-upping with managers with a proven track record, investors may choose to stick with the manager they know.

In fact, Fiona Anderson Wheeler of BC Partners told SS&C Intralinks that re-ups have taken up virtually all of this year's allocations. As a result, it may be extremely difficult for emerging managers to attract new capital in the first half of 2023.

Asset class overweights and underweights

As more institutional investors recognize private equity's sizable contributions to their portfolios, it comes as little surprise that many expect to be overweighted on PE. 29% of respondents expect to be overweighted on private equity, the largest percentage of any of the alternative asset classes.

Hedge funds were in second place, with 21% of investors expecting to be overweight on the asset class, followed by venture capital at 14% and private debt at 13%. On the other hand, venture capital was the most underweight asset class for about 24% of investors.

Interestingly, hedge funds were also in second place for the most underweight alternative asset class. Some of this push and pull between overweighting and underweighting hedge funds may be due to the wide variety of strategies employed.

Multiple other studies have shown that macro hedge funds have been the big winners in 2022. For example, global macro hedge funds averaged a return of 8.5% for the first half of this year, according to HFR.

Those returns are unique to macro strategies and stand in stark contrast to returns across the broad hedge fund industry. Across all strategies, hedge funds averaged a return of -5.6% for the first half of 2022, according to the Financial Times. Equity-focused funds have been especially hit hard this year.

Michelle Jones contributed to this report.