I N V E ST M E NT M A N AG E M E NTTransformationThe Future of Alternative InvestmentsF I N A N C I A L S E RV I C E S
AcknowledgementsThis report, produced by KPMG International in cooperation with InternationalFund Investment, examines in ...
Contents                                                               About this research	                               ...
© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independ...
About thisresearchTransformation: The Future of Alternative Investmentsexplores the ways in which the alternative investme...
HeadlinemessagesThe following headlines represent the views expressedfrom each of the three main groups of participantsinv...
•      The overwhelming majority of existing alternative investors are happy to                                           ...
ExecutiveSummary“Twas the best of times, ‘twas the worst of times.‘Twas the age of wisdom, ‘twas the age of foolishness”Ch...
What do you believe are the major challenges facing the alternative investment   industry over the next 3 years?          ...
What do you think will be the impact of forthcoming regulations in the below                                              ...
A new breed of manager and what it means for the industry                                                               As...
The rise of the ‘entrepreneurial institutional’ manager does not, however, signal an                                      ...
Managed accounts: great in theory, more difficult in practice                                                             ...
Twin track alternative fund domiciliationThe alternative investment industry has always been drawn to offshore jurisdictio...
What do you think are the key challenges facing the administration industry over    the next 3 years?                     ...
However, with demand comes challenge. Despite a significant investment in                                                 ...
There is now evidence that bifurcation is also occurring between institutional                                            ...
The future is much bleaker for smaller fund of fund managers. For far too many, the                                       ...
What impact, if any, has the market crisis and/ or the news of recent financial    scandals had on your operational due di...
“Only when the tide goes out do you      discover who’s been swimming naked”      Warren Buffet     Managers              ...
Products and performance                                                                   Which alternative investment pr...
As investor appetite for absolute returns                       higher risk bonds and other investments                   ...
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Transformation future alternative_investments

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In dit rapport wordt de overgang van de alternatieve beleggingssector inhoudelijk onderzocht op het moment dat de sector aan het begin staat van een periode van aanzienlijke groei terwijl de sector nauwlettend in de gaten wordt gehouden door regelgevers en institutionele beleggers.
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Onderzocht wordt hoe beheerders van alternatieve beleggingen, institutionele beleggers en vermogensbeheerders, in het licht van een grote volatiliteit van de markt en de onzekerheid op het gebied van regelgeving, hun bedrijfsmodellen aanpassen voor een zo groot mogelijke kans op succes.

Over het onderzoek
Tot eind 2007 heeft de sector voornamelijk een ononderbroken groei vertoond. Van 2007 tot 2009 ging een reeks dramatische marktgebeurtenissen gepaard met slechte resultaten, die in een aantal gevallen nog eens werden verslechterd door operationele tekortkomingen. Dit heeft geleid tot een totaal verlies aan vertrouwen in de sector. Sinds begin 2009 zijn de vooruitzichten van de sector aanzienlijk verbeterd. De kredietcrisis raakt steeds meer op de achtergrond. Managers verfijnen hun bedrijfsmodellen en focus; institutionele beleggers beoordelen allocaties en operationele vereisten; vermogensbeheerders bekijken technologie en de arbeidspool; en de sector als geheel bereidt zich voor op de verwachte gevolgen van de toegenomen regelgeving. Het is duidelijk dat de structuur van de sector in de toekomst enorm zal verschillen van die van nu.

Het rapport, dat is geschreven in samenwerking met International Fund Management, is gebaseerd op taxaties en gestructureerde interviews die wereldwijd tussen februari en juni 2010 zijn gehouden. Het succes van het onderzoek is te danken aan het grote aantal deelnemers van 200 respondenten in 26 landen, onder andere bestaande uit alternatieve beleggingsbeheerders (US$ 515 miljard beheerd vermogen), vermogensbeheerders (US$ 4,2 biljoen beheerd vermogen) en institutionele beleggers (US$ 884 miljard beheerd vermogen). Naast interviews met bovenstaande groepen zijn er tevens interviews gehouden met advocaten en onafhankelijke directeuren.

Verwijzingen in het rapport naar alternatieve beleggingsbeheerders zijn gebaseerd op een steekproef van respondenten die beleggen in (een combinatie van) hedgefondsen, private equity, vastgoed, infrastructuur en gestructureerde producten, ook al heeft men zich voornamelijk op de hedgefondssector gericht.

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Transcript of "Transformation future alternative_investments"

  1. 1. I N V E ST M E NT M A N AG E M E NTTransformationThe Future of Alternative InvestmentsF I N A N C I A L S E RV I C E S
  2. 2. AcknowledgementsThis report, produced by KPMG International in cooperation with InternationalFund Investment, examines in detail the transformational change of the alternativeinvestment industry as it enters a period of significant growth, set against scrutinyfrom regulators and institutional investors. It investigates how, in light of significantmarket volatility and regulatory uncertainty, alternative investment managers,institutional investors and administrators are adapting their business models tomaximize chances of success.Our foremost thanks go to 200 organizations from 26 countries who participated inthis research.We would also like to offer our special thanks to those 85 CEOs, CIOs and Board levelDirectors who participated in our structured interviews. Their insights and foresightshave helped produce a comprehensive vision of the future of alternative investments.We would also like to thank the members of the project team, editorial board, andother colleagues around the world who have helped us in carrying out this research, inparticular: Marie Parker from KPMG in the Cayman Islands, Mireille Voysest and UnaClarke from KPMG in the UK, Cara Scarpino from KPMG in the US, and Simon Osbornand Rebecca Gooch from International Fund Investment.Anthony Cowell Andrew StepaniukPartner PartnerKPMG’s Investment KPMG’s InvestmentManagement Practice Management PracticeProject Team Chaired by Anthony Cowell, KPMG in the Cayman IslandsGiles Drury, KPMG in the UKMikael Johnson, KPMG in the USJon Mills, KPMG in the UKAndrew Stepaniuk, KPMG in the Cayman IslandsSimon Whicker, KPMG in the Cayman IslandsKPMG Editorial Board*Chaired by Wanda MellaneoKris Beighton Grant GreenKeith Blake Mark Harris Tully Cornick Tanis McDonald** Gordon Rajamohan*KPMG in the Cayman Islands**KPMG in the BVIAdditional ContributionsLeah Dering-Ridley, KPMG in the UKTim Fundell, KPMG in the UKNicholas Griffin, KPMG in the UKDavid Yim, KPMG in the UK© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  3. 3. Contents About this research 1 Headline messages 2 Executive summary 4 Alternative Investment managers 16 Administrators 26 Institutional investors 36© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  4. 4. © 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  5. 5. About thisresearchTransformation: The Future of Alternative Investmentsexplores the ways in which the alternative investmentindustry is adapting and evolving.Up until late 2007 the industry had largely enjoyed uninterrupted growth. From ,2007 to 2009 a series of dramatic market events coupled with poor performance, Location of participants:exacerbated in a number of cases by operational shortcomings, resulted in an overall Australialoss of confidence in the sector. Since early 2009, the industry’s fortunes have Austriaimproved considerably. The credit crisis is receding into the background. Managers are Bahamasrefining business models and focus; institutional investors are reviewing allocations Belgium Bermudaand operational requirements; administrators are eyeing technology and the labor Brazilpool; and the industry as a whole is preparing for the anticipated impact of increased British Virgin Islandsregulation. What is clear is that the structure of the industry ahead will be vastly Canadadifferent than it is today. Cayman IslandsWritten in cooperation with International Fund Investment, this report is based on Chinasurveys and structured interviews conducted globally between February and June Curacao Denmark2010. The study has benefited from the participation of 200 respondents across France26 countries, and includes: alternative investment managers with US$515 billion Guernseyunder management; administrators with US$4.2 trillion under administration; and, Irelandinstitutional investors with US$884 billion under management. In addition to the Jerseyabove groups, interviews were also conducted with lawyers and independent Koreadirectors. Luxembourg MaltaReferences within the report to alternative investment managers are based on a Netherlandssample of respondents that invest in either (or a combination of) hedge funds, private South Africaequity, real estate, infrastructure and structured products, although the main focus Swedenhas been on the hedge fund sector. Switzerland United Kingdom United Arab Emirates United StatesThe information reflected in the graphs and charts was obtained by KPMG International Cooperative andInternational Fund Investment during both the structured interview stage and questionnaire stage. Theanonymous interview quotes throughout this document were obtained during the interview stage of theresearch project. Please note that with the graphs illustrated, not all answers add up to 100 percent becauseof rounding or because respondents were able to provide multiple answers to some questions. The Future of Alternative Investments © 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  6. 6. HeadlinemessagesThe following headlines represent the views expressedfrom each of the three main groups of participantsinvolved in our research: alternative investment managers,administrators and institutional investors. Their insights aredeveloped as 10 key themes in the rest of this executivesummary, and further in sections 2, 3 and 4. Together, theyprovide a detailed analysis of the future of the alternativeinvestment industry as it faces unprecedented change.• The majority of institutional investors intend to increase their allocations to alternative investments in the next 3 years. As a result, they will have a far greater influence over the shape of the industry in the future.• Anticipated regulation, driven by external forces that continue to blame alternative investments for the meltdown of the global financial system, is not wanted by the majority of investors, managers or service providers. The widely held view is that the industry did not cause or contribute to the credit crisis. Furthermore, investors believe more regulation will not produce any tangible benefits.• Managers and administrators believe that regulation and governance are the most important challenges facing the alternative investment industry over the next 3 years.• There will be four different manager business models that will come to dominate the industry in future. In addition to ‘niche’ boutique managers and the ‘super-boutiques’ (independent managers moving on to become multi-billion dollar players) there will be further and significant development of managed account platforms as well as the emergence of what might be termed the ‘entrepreneurial-institutional’ manager.• Investors forecast that managed account structures will experience substantial growth. Whilst their benefits include improved transparency, liquidity, control and customized fee arrangements, managers believe that cost and operational complexity are some of their key shortcomings.• Investors want a better alignment of interests with managers. The main changes will likely feature longer term performance fee arrangements, increased capital investment from managers, and a move towards enhanced liquidity and transparency. The Future of Alternative Investments© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  7. 7. • The overwhelming majority of existing alternative investors are happy to continue to allocate to funds that are located in offshore jurisdictions. • There will be a further move towards independent administration, particularly in the US where many alternative investment managers administered their funds in-house. This will exacerbate the capacity mismatch that is developing in the industry. Administrators report that they are operating at near to full capacity whilst less than half of managers interviewed stated that they are in a similar position. • The ‘bifurcation’ of the alternative investment industry is continuing. Newer institutional investors into alternatives are more likely to be attracted to managers promoting funds with greater liquidity and transparency than experienced, longer term institutional allocators. • Levels of investor satisfaction with alternative allocations are correlated to the length of time that they have been active in allocating to alternatives because of their detailed understanding of the industry. Investors with the most experience of this activity tend to be the most satisfied with their allocations. • There is little to no consensus amongst investors on the route to take to allocate to hedge funds. The popularity of fund of funds is in decline but there is no obvious replacement for most investors. As a result the well known billion dollar fund of funds will prosper but there is also likely to be significant consolidation amongst the smaller players. • Manager fee structures are expected to be less uniform in the future, as institutional investors negotiate more local agreements. • Barriers to entry from regulation and institutionalization will impact the rate of new start-ups. Moreover, managers with assets of less than US$100m will find it increasingly challenging to run a long term business as a result of increased costs from regulation. • Fund servicing related issues are growing in importance. Investors now take fund servicing very seriously and a number of managers report that events over the last 18 months have had a dramatic effect upon the type of firms that they would want to hire as service providers. • The fallout from the credit crisis and events such as Madoff have led to substantially increased levels of due diligence across investment management, particularly from institutional investors. The Future of Alternative Investments © 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  8. 8. ExecutiveSummary“Twas the best of times, ‘twas the worst of times.‘Twas the age of wisdom, ‘twas the age of foolishness”Charles Dickens The era of transformation One of the constants in the alternative investment industry is the presence of “For a brief moment, the industry change. From its origins to expansion in the 1990s and through the explosive growth had a heart attack. It’s now being of the 2000s, the one thing that the industry could count on was continued change. resuscitated” However, in reality, the basic structures of the alternative investment business were not very different in 2007 than they were in 1997 The industry was a great deal . larger but practices and structures remained largely unaltered. Investors considering alternatives, including the world’s largest institutions, had to do so on the manager’s terms, not their own. Those days are now over. The industry is going through a period of transformational adjustment to a very different and more regulated operating environment. The majority of institutional investors included in the survey intend to increase their allocations to alternative investments in the next 3 years, with some intending to allocate over 10% of their total assets. As a result, these investors will have a far greater influence over the shape and culture of the industry in the future - they will demand institutional grade controls, increased transparency and flexible product strategies in order to invest their capital. In addition to the credit crisis, events such “Headline risk scares us out of as Madoff, whilst not a hedge fund, highlighted the need for a robust due diligence our minds” process. The influx of more institutional capital into alternatives will result in further substantial growth of the well known, billion-dollar managers. The desire for more transparency and liquidity is the main driver behind the recent growth in new product structures in hedge funds, including managed accounts and managed account platforms as well as onshore regulated products. Managers are being forced to make adjustments to the new environment, whether they like it or “Transparency, liquidity and not (and some emphatically do not). For many of them, the frustration of having to understanding risk are paramount; everything else is a bonus” review internal procedures and systems, consider different domiciliation options, gear up for more regulation and so forth has a pay off. They believe that this painful and expensive process will enable them to attract many more and different types of investors to their funds. The Future of Alternative Investments© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  9. 9. What do you believe are the major challenges facing the alternative investment industry over the next 3 years? 75% “We always want to see alignment Regulation and governance 67% of interests. If the manager isn’t 97% prepared to lose his shirt then we’re 63% not in the business of investing” Investment performance 44% 56% 55% Transparency 78% 56% 55% Liquidity risk 33% 13% 43% Downward fee pressure 33% 34% 35% Operational risks 44% 28% 25% Taxation 31% 20% Managers Systemic risk Insitutional Investors 6% Administrators 13% Shortage of talent 13% “Growth will be phenomenal, unless regulation stifles it” 0 20 40 60 80 100% of respondentsThe paradox of regulationThe results of this survey show that the anticipated increase in regulation is notwanted by the majority of investors, managers or service providers. Despiteregulation being widely promoted as a way to protect the investor, it is these investorswho are most strongly against it. Few investors believe it will produce any tangiblebenefits. Some see it as being protectionist to certain jurisdictions and thereforedetrimental to the development of the global alternative investment industry whilstothers fear that it will inhibit the competitive positioning of investment managers “The halcyon days are back – we wantby adding to costs. As a result, many investors in Europe believe it will reduce the star performance and star treatment!”number of new start-ups, thereby stalling the industry’s engine of creativity – theproduction line of boutiques that provide vitality and talent in the future. The Future of Alternative Investments © 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  10. 10. What do you think will be the impact of forthcoming regulations in the below regions on worldwide growth of alternative investments? “Fear and greed motivate managers - both in equal proportions” Managers 13% 51% 36% Asia Administrators 10% 61% 29% I. Investors 11% 78% 11% Managers 44% 38% 18% North 32% 35% 33% Administrators America I. Investors 67% 22% 11% Managers 64% 18% 18% Europe Administrators 72% 6% 22% I. Investors 56% 33% 11% 0 20 40 60 80 100 Positive Impact Neutral Negative Impact % of respondents Nevertheless, the universal view is that further regulation is on the way. Investors, “Independent directors are the managers and service providers take a fatalistic approach to this subject. It is viewed panacea for the industry. Too much as an inevitable consequence of the recent well publicized scandals affecting the self interest is a bad thing” industry, combined with the dramatic market volatility in recent months. Furthermore, numerous respondents made the point that alternative investments were in no way responsible for the market crisis. Indeed they were often victims themselves. Nonetheless, managers recognise that they cannot escape from the increase in “All the talk of extra regulation is financial regulatory supervision occurring around the world. creating insecurity amongst investors” Regulation is coming to the alternative asset management industry on both sides of the Atlantic. The impact of various US regulatory and legislature initiatives, including the so called ‘Volcker’ rule, which proposes a ban on proprietary trading by banks, will likely be considerable for the alternative investment industry, as talent migrates towards boutiques. In Europe, the Alternative Investment Fund Managers Directive “Making money is obvious; telling (the “AIFM Directive”) is closer to finalization. The European Parliament’s Committee everyone how you’re going to do it is the challenge” for Monetary and Economic Affairs recently voted for the draft directive and the EU council’s group of finance ministers followed suit on its version of the text. The Future of Alternative Investments© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reser ved.
  11. 11. A new breed of manager and what it means for the industry As the alternative investment industry expands and matures so it continues to add “This is going to be a really critical variety to its manager models. The business started as a fragmented collection year for a lot of managers... 2010 is of niche boutiques. As the industry developed, a number of these managers then the right time for them to prove became ‘super-boutiques’ - investing institutions in their own right. For many years, their worth” the industry was characterized as being divided between these multi-billion dollar ‘super-boutiques’ and numerous smaller ‘niche’ boutiques. Forces pushing and pulling the Alternative Investment industry between boutique and institutional Timeline 1990 2010 Super Entrepreneurial- Pure Boutique Boutique institutional institutional • Owner/Manager led • Partners/shareholders • Performance and innovation • Asset gathering • Creativity • Standardization • Flexibility The • Processes and rules • Lifestyle Alternative • Diversification • Infrastructural • Strong governance/ constraints Investment control • Low staff numbers and/or Industry • Regulation e.g. staff retention EU AIFM Directive • Regulation • Transparency e.g. ‘Volcker’ rule • Liquidity • Small service providers • Brand name service providers Two other types of structures have come into the business to challenge the boutique model. In addition to the next generation of niche boutique managers and the ‘super- boutiques’, there will be further and significant development of managed account platforms as well as the emergence of what might be termed the ‘entrepreneurial- institutional’ manager. ‘Entrepreneurial-institutional’ managers started out as smaller alternative “Administrators had to step up their investment managers but have since diversified their businesses into mainstream game, and they have done” fund management, as well as other complementary investment activities such as financing, private placements, proprietary trading, restructuring, and structured products. This development will have consequences for the entire financial world, not just alternative asset management. ‘Entrepreneurial-institutional’ managers will be able to outflank competitors by offering allocators a range of investment opportunities covering other alternative, and perhaps even mainstream, asset classes. Their controls “Blow ups happen because no-one and processes are likely to be institutional grade, yet they retain their creativity and understands the strategy” focus on alpha, rather than asset gathering. The Future of Alternative Investments © 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  12. 12. The rise of the ‘entrepreneurial institutional’ manager does not, however, signal an end to the boutique – far from it. As the industry institutionalizes, through increased bureaucracy, formalization and rigidity, the allure of reward, creativity and freedom “Three years ago, investors were will continue to attract talent to the niche end of the industry. Hence, the number looking for a hot manager; now of boutiques will thrive. Furthermore, their numbers may be impacted considerably the focus is on more established by the proposed ‘Volcker’ rule in the US, as proprietary traders are forced out of managers with proven track records” the mainstream to set up their own firms. Nonetheless, if they are successful in their diversification strategy, whilst maintaining healthy performance in their core funds, the coming breed of ‘entrepreneurial-institutional’ managers will likely attract a large proportion of institutional capital – the boutiques may be able to compete on numbers, but not on asset size. The Matrix: Growth and Transformation US$5 billion + US$5-20 billion + US$20 billion + • Global investment management capability • Strong risk-governance arrangements (US, Asia, EU) (comprising 3 lines of defence, multiple governance committees with integrated risk/ control framework and non-exec directors) Global • Formalized risk/control arrangements (high degree of discipline and formalized control evidence); and strong compliance culture • High focus on assurance agenda – SAS70/AAF/ GIPS/HFSB • High degree of transparency • Regulator “relationship-managed” Super Boutique US$1 billion + US$3 billion + US$10 billion + • International sales reps (US, Asia, EU…) • More formalized risk-governance arrangements (Board/Executive Committees) • Moderate adoption of investor assuranceGlobal Reach International agenda e.g. SAS70 or GIPS • Greater degree of process/control discipline • Moderate interaction with regulatory bodies Entrepreneurial Institutional Manager US$100 million + US$1 billion + US$5 billion + • Entrepreneurial, craft orientated • Multiple funds / managed accounts • Multiple product ranges (Hedge funds, absolute • One main fund • Multiple strategies return strategies, long only) • Low degree of transparency • Multiple distribution channels – fund of funds, Single Office • Informal risk-governance/control arrangements managed accounts, retail, direct • High degree of reliance on legal vs compliance • Performance focused, no mediocrity culture • Low relationship with regulator (deemed “low risk”) Boutique Single Product Multiple structure / product Multi Channel Product Breadth The Future of Alternative Investments © 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.
  13. 13. Managed accounts: great in theory, more difficult in practice Separately managed accounts have always been a mainstay of the investment “There is no shortage of talent. management industry. Managed account platforms, however, are a relatively new Money supply is the biggest phenomenon. challenge” Using managed account structures as a method of investing in alternative investments, has become considerably more attractive than fund of funds with institutional allocators. Investors surveyed forecast that managed account structures will experience substantial growth. (After direct investment into single manager funds, managed accounts are predicted to see the largest increase in asset allocations over the next 3 years.) The control that managed accounts offer investors was mentioned by all those that use, or intend to use, these structures. After control, liquidity (in particular avoiding gates, lock-ups etc) and transparency were the next most popular reasons for turning to managed accounts. As a result, managed accounts are being used almost “Stars are the life source of the systematically by large institutions when they wish to make a large allocation to a industry; they know what they want manager. and they know how to get it” However, managed accounts have drawbacks. Their biggest drawback is that they do not provide access to all managers or strategies. They are also difficult to implement for illiquid strategies, like distressed funds, due to increased reporting and administration demands. In addition, investors are conscious of the added costs, resources and responsibilities that are imposed upon them. Only large institutions have the means to employ the staff to implement and monitor a successful managed accounts program. Other concerns included performance diminution and the fact that they place more operational risk on the investor (and less on the manager). In addition to complexities with implementation, capacity constraints are already emerging in the managed account sector and investors are likely to have some difficulty finding the managers they want via these structures. Managers interviewed complain that “We want respected names, known managed accounts are taking up too much of their time and resources. They are to investors, on the prospectus” concerned that their own fund investors must come first. Some managers have declined to take on managed accounts and others are imposing limits. Imposing limits on managed accounts could become a badge of honour with successful, well known managers in the future. Pre market crisis, finding capacity with such well regarded managers, those that were often technically closed, was a concern for large investors. Post crisis, a variation of this problem could reappear within the managed account universe. Hence, direct investment into alternative investments is forecast by investors to increase more quickly than investment via managed accounts over the next three years. The Future of Alternative Investments © 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  14. 14. Twin track alternative fund domiciliationThe alternative investment industry has always been drawn to offshore jurisdictions.They have grown up together. These domiciles are ideal locations both for theiroriginal core investors – the high net worth crowd – and managers. Locationsoffering regulation where it is quick, flexible and inexpensive to launch funds arewhat alternative managers want. However, a combination of increased investornervousness, and the evolving regulatory environment have led managers toquestion whether they should continue to domicile their funds offshore or re-domicile onshore. Some managers have taken the step of re-domiciling onshore. “The credit crunch was a symptom,Others have launched funds in onshore locations, such as Dublin, whilst keeping not a disease”their offshore funds in operation.Results indicate that the overwhelming majority of investors are happy to continueto allocate to alternative funds that are located in offshore jurisdictions. There is noevidence that the domiciliation structure of the alternative investment industry isof concern to those that currently allocate to these products. These respondentsrepresent the bedrock of the industry’s investor base. Investors in this category oftenview with disdain more regulated alternative fund domiciliation, which has becomesomething of a craze in Europe.In addition, investors with longer tenures of investing in alternative investments tend “Politics and regulation are killingto be the least concerned with operational issues and fund domiciliation, whilst being our business. We can work on ourthe most sceptical that more regulation is in any way beneficial. Managers would performance, but its difficult to worktherefore be wise to maintain their offshore fund range for their bedrock investors. For on politics!”the next wave of investors, a different strategy looks likely to be beneficial to securesuch investors’ capital (at least for European allocators). They are more likely to wantonshore funds in addition to their offshore structures.Alternative investment domiciliation is diverging. The traditional homes of the hedgefund and private equity industries are not under significant threat. They will continueto be the logical place to go for funds aimed at the traditional alternative investor.However, EU domiciles are developing complementary structures to compete forthis business and appeal to the new generation of investors. How these funds fareremains to be seen.The growing role of the administratorThird party, independent fund administrators find themselves in a pivotal positionas the alternative investment industry is transformed in this new era of increasedregulation, investor scrutiny and institutionalization.10 The Future of Alternative Investments© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  15. 15. What do you think are the key challenges facing the administration industry over the next 3 years? 66% Continuous IT development and investment 43% 66% Regulatory compliance 63% 59% “Institutional investors are like royalty Independent valuation of complex securities 65% - they attract a lot of interest in your fund but they come at a price” 50% Maintaining margins asassets under management fall 28% 19% Developing a sustainable client base 33% Administrators Managers 16% Shortage of skilled staff 40% 0 10 20 30 40 50 60 70% of respondentsAdministrators are at the center of structural changes occurring throughout theindustry. Increased standardization of administration will be the main change,particularly with regards to reporting transparency and liquidity requirements forinvestors. The anticipated increase in regulation is also forecast to have consequences “Investors did not like being told theyfor all industry practices, including administration. One respondent referred to the couldn’t have their money back”speed at which internal control reports (e.g. SAS70) have become standard in theindustry as an example of how quickly practices can change.Administrators included in our survey also believe there will be significantdevelopments in the use of technology, in order to keep pace with increaseddemands placed upon their businesses by the alternative investment industry. Therewill be a requirement to accommodate an exponential increase in data demandedfrom fund managers, investors and regulators. As a result, administrators will need “Managers need administrators morerobust and flexible technology platforms that are capable of high volume transaction than ever”processing and customized ‘real-time’ reporting. Furthermore, for several years,administrators have been diversifying into services that are complementary totheir core activities, such as performance attribution analysis and risk reportingservices. The new environment is likely to see an acceleration of complementaryservices offered, including functions that support managers’ front and middleoffice activities. In Europe, administrators have been particularly successful indiversifying their product range to capture reporting requirements for UCITS funds. “Administrators have distancedGlobally, it is significant that when asked the question, ‘Which services do you themselves from their responsibilities;provide currently and which do you expect to grow significantly in the next 3 years?’ the crisis has driven them to seekAdministrators said that they expect there will be a big jump in front and middle legal protection”office services and risk management. The Future of Alternative Investments 11© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  16. 16. However, with demand comes challenge. Despite a significant investment in technology, the administration industry remains very labor intensive and lacks operational leverage. There is an increasing capacity mismatch, with nearly 3 in 4 “No matter what any manager will tell administrators operating at between 71-100% capacity. MA activity is therefore you, if the world falls apart again and inevitable. A number of administrators have already expanded into other areas and everyone runs for the doors, you’re we are beginning to see convergence (hedge fund administrators buying into private not going to get your money back!” equity for example). New firms and new product offerings are also likely to emerge to service the operational demands of clients. If alternative inflows develop as forecast, or anywhere near to it, administrators will face serious infrastructural challenges. This is an issue that few have yet to address. The bifurcation business Bifurcation of the alternative investment industry is occurring in a number of ways. It “Leverage is an unpopular word can be seen in the growing gulf between the boutiques, those managers that have these days; its making it hard to raise stayed focused upon implementing their particular specialist investment strategy, and capital” a number of the multi-billion dollar managers that diversified into other areas of the market and/or whose business models have moved beyond fund management.12 The Future of Alternative Investments© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  17. 17. There is now evidence that bifurcation is also occurring between institutional “You don’t send a football team ontoinvestors. The offshore fund industry will continue to serve the majority of those the field without some reserves.currently investing in alternatives, largely sophisticated and experienced investors Why would we do the same here.who remain satisfied with its structure. However, new investors into alternatives We’re always looking for starare more likely than seasoned allocators to be attracted to managers promoting managers and have reserves tofunds with greater liquidity and transparency than is typical in traditional alternative allocate when we find them”structures. This has been an important part of the reason for the growth in UCITS,or ‘Newcits’, funds in Europe. Meanwhile, much of the wealth management sector,as well as the longest serving and most sophisticated institutional investors, remainprepared to allocate to funds in offshore jurisdictions that are less transparent andconsiderably more illiquid than alternative UCITS products. These investors are alsomore understanding of industry practices such as gates, lock-ups and side-pockets,that evolved and were subject to so much criticism during the credit crisis.The continued establishment of onshore regulated products will fundamentally “We won’t accept lock ins anymore;change the dynamics of the alternative investment industry. It is likely to lead to a we’ll barely tolerate gates”considerable increase in fund launches as parallel, or ‘mirror’ funds, are launchedin onshore locations that mimic established offshore funds. Established offshorejurisdictions will continue to thrive and prosper in the new environment. Therewill also be a lot of activity in locations such as Ireland, Luxembourg and Malta asalternative UCITS become established in Europe.The changing structures available to allocatorsThe way in which institutional investors currently access alternative investments Do you believe the alternativewill change in the next 3 years. At present, investors generally allocate capital to investment industry will become...alternative investments through fund of funds, managed accounts, indexed productsor direct investment. Institutional investors with the requisite resources are now 5%6% 6%moving to a hybrid allocation model. A clear trend in favor of single manager fundsand managed accounts is emerging as allocations to fund of funds diminish. 13%Fund of funds did not have a good market crisis, say their investors. Their raison d’êtreto reduce market risk through enhanced diversification failed to materialize when 14%it mattered most. Whilst large institutional investors favor a hybrid model of singlemanager funds and managed accounts, smaller institutional investors have more 49%limited allocation options and fund of funds will remain their gateway to the industry. 33%A number of these investors note that larger fund of funds are proving to be adaptable 74%and innovative; some have enhanced their communication with investors and providea far more customer centric experience.Fund of fund managers with assets in excess of US$5 billion have the resources to More Bifurcated betweenexpand into managed accounts and to diversify their offerings in other ways. In 2010 large asset providers institutional and small boutiquesand beyond, the best of these large, multi purpose operations are likely to continueto expand into new areas (offering investors different structures and strategies). More boutique Remain focused the sameConvergence and divergence across strategies and structures will drive consolidation.Recent mergers in the hedge fund industry, including that of two well known firms % of respondentsin the business, both with assets in excess of US$5 billion, are an example of this.This is widely expected to lead to a further wave of MA activity. There is alwaysa possibility that something similar to the ‘merger mania’ that gripped the custodyindustry in the 1990s could be replicated amongst today’s independent alternativeasset managers. The Future of Alternative Investments 13© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  18. 18. The future is much bleaker for smaller fund of fund managers. For far too many, the market crisis exposed shortcomings in their core business proposition. Unlike their larger competitors they do not have the resources to fight back. The largest fund of funds are diversifying and/or using their brand name to attract institutional and high net worth investors in order to grow in different directions. But the smaller players are unable to compete in these areas. They are struggling. Challenge to the 2 and 20 The majority of investors interviewed do not believe that the industry’s 2 and 20 fee “We’ll pay performance fees for structure is sustainable. Whilst not top of their list of priorities for industry reform, performance but we don’t like fee reduction is still something that they want and anticipate will happen. Equally, a manager making money from manager fee structures are expected to be less uniform in future. management fees” Manager fee structures are under pressure because investors have much greater negotiating power as a result of the market crisis. Added to which the industry is being driven forward by super-sized allocators. They have always been able to negotiate lower fees, including with many of the most sought after managers. This was common practice even at the height of the boom. It is these institutions, with their significant fee negotiating power, that are chiefly responsible for the recent strength of inflows into alternative investments. In addition, a number of the largest institutions want to see more alignment of their interests with managers. They believe managers should make a greater effort to build a long-term business compensation culture. For certain strategies, this may simply require a performance hurdle feature. One institution made the point that they are long term investors and they want to work with managers who think, and act, like them. There is evidence that a number of the more recent start-ups have recognized this issue by redesigning their business models to incorporate longer term fee structures and hurdle features. It is believed that differences in fees will only grow in the future. The uniformity is gone. In its place will be many more ‘local’ agreements. Some managers will be able to charge more than 2 and 20, as has always been the case. But results from this research suggest that with the largest institutional investors in the driving seat, most fee negotiations will be going in the opposite direction. Professional fund servicing is now key to investor contentment Fund servicing related issues are becoming ever more important for investors. “Fund servicing issues are the most The growing institutionalization of the industry have made topics surrounding fund important business decisions that you servicing central to the well being of the industry. Fund servicing issues such as can make. 60% of the success of the investor demands for due diligence procedures had been growing in importance well fund depends upon it” before Madoff, a fraud that has added impetus to this trend. That such a relatively simple fraud could have taken place on such a large scale in a highly regulated environment, indirectly affecting numerous investors, has profoundly shocked many constituents across financial services. All investors now take fund servicing very seriously. A number of managers noted that events over the last 18 months have had an effect upon the type of firms that “We’re asking so many questions, they would want to hire as service providers. Recognized names that prospective we don’t have space to write the investors are familiar with have become more important than was the case pre crisis. answers” It has become essential to have organizations listed on the fund’s prospectus that reassure investors. Service provider name recognition is becoming paramount.14 The Future of Alternative Investments© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  19. 19. What impact, if any, has the market crisis and/ or the news of recent financial scandals had on your operational due diligence process? 43% Managers 49% 8% High Impact 41% “Hedge funds were not out of control; Low Impact they did not cause the crisis” Administrators 53% No Impact 6% 67% I. Investors 22% 11% 0 10 20 30 40 50 60 70 80 “Our checklists have doubled”% of respondentsAs the industry grows its institutional investor base, managers expect that scrutinyof their operational procedures by investors will only increase further in future.This includes their third party service providers. Due diligence on administrators, inparticular, has become a lot more intrusive and regular. In 2009 alone, administratorssay that there was a substantial increase in investor requests for due diligence “Robust due diligence is critical –meetings as well as detailed and regular due diligence reports. One administrator has we won’t even open the door to anoted that this type of activity has increased by 30% alone in 2009. manager without this”The point is that the institutional investor now has far more power to shapeoperational aspects of the industry, as a result of the sheer weight of its capital.Managers surveyed say that both their existing and prospective investors andregulators want clear and transparent operational oversight. This is now occurring. “High Net Worth investors have been hibernating for over a year now; surely its time they woke up” The Future of Alternative Investments 15© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  20. 20. “Only when the tide goes out do you discover who’s been swimming naked” Warren Buffet Managers This section presents the results from the survey and structured interviews involving alternative investment managers. Case studies with industry participants are presented at the end of the section. Core capacity “In a downturn, transparency is trendy, but when the industry moves The supply side of the alternative Approximately, how much of your investment industry has changed company’s core capacity is currently on, trends change. The return to the being used? status quo is inevitable” considerably in recent years. Prior to the credit crisis, questions were raised regarding the availability of talented 6% 1% managers who could generate alpha at 6% a rate demanded by investors. Currently, 21% there is significant amount of capacity available to manage funds, with only 44% 14% two in five managers operating at or near full capacity. 13% “Sometimes the red flags are so Our interviews revealed evidence of a next generation of talent migrating 74% huge, you have to close your eyes from brand name investment houses 21% to miss them. Even then, your other to set up new businesses. Whilst the senses tell you its not quite right” industry continues to institutionalize, the allure of reward, creativity and freedom 10% 10-30% 31-50% on offer from the boutique sector will always attract alpha generators. Hence, the number of boutiques will continue to thrive, although in capital terms, they 51-70% 71-100% will represent a far smaller proportion of % of respondents the industry. The pace of change may be impacted further by the proposed ‘Volcker’ rule in the US, as proprietary traders are forced out of the mainstream. The future choice for investors looks bright - the difficulty will be finding the star in all the mediocrity.16 The Future of Alternative Investments© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  21. 21. Products and performance Which alternative investment products do you expect your clients will be attracted to in the next 3 years? Single strategy hedge funds 59% Private Equity 39% Multi strategy hedge funds 33% Fund of hedge Funds 28% Structured products 26% Real Estate 26% Infrastructure 22% Reinsurance products 4% Other 13% 0 10 20 30 40 50 60 % of respondents “Our investors want us to do well, but there are plenty waiting to write about What returns do they expect? us if we fail” Private Equity 19% 50% 19% 12% Multi strategy 42% 58% hedge funds “I feel sorry for administrators - Infrastructure 43% 57% they get a tough deal, but at last they’re being recognized as being an important part of the process” Structured products 50% 30% 20% Single strategy hedge funds 23% 73% 4% Real Estate 62% 38% Fund of 78% 22% hedge Funds 0 20 40 60 80 100 “Investors got hurt, but time is a great 1-10 % 11-20 % 21-30 % 31-40 % healer” % of respondents The Future of Alternative Investments 17© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.
  22. 22. As investor appetite for absolute returns higher risk bonds and other investments continues to grow, over 3 in 5 managers such as art funds. expect that single strategy hedge funds Hedge fund and private equity products will be the main route to market, with “When the markets are rising, who are preferred by managers – an indication, the majority of them expecting returns of cares about hedge funds when you perhaps, that investors have short can have long only” between 11-20%. This data is confirmed memories and are willing to try again, by investors who are increasingly albeit under new and improved terms. searching for direct investment into funds. From our interviews, it is clear that the fund of fund industry is at a crossroads. Expectations for returns favor private Transparency, liquidity, alignment of equity, single strategy hedge funds interests and customer centricity are all and structured products, although it is changes which the industry is making. unlikely that we will see a significant Many managers commented that they “Regulation is depressing; its costly increase in the latter before the next lost sight of investors and with that the and will not prevent a year. Whilst investors have short trust between investor and manager blow up” memories, they will likely not forget was broken. The surviving fund of fund the term CDO (“Collateralized Debt brand names will continue to thrive Obligation”) in a hurry. The events as institutional investors have limited in recent years, however, have not opportunities with which to access caused the structured product industry talent. For the smaller fund of funds, to close, and a number of larger there needs to be a mindset change managers have expressed a desire towards the investor, and improvements to ramp up their CLO (“Collateralized “We didn’t lock down investors. in communication will be essential. Now we’re getting the benefit of that Loan Obligation”) businesses when Nonetheless, we are likely to see confidence with new investments” the market fundamentals change. Our stronger asset growth from managed interviews suggest that investors are account platforms in the next 3 years regaining confidence in the sector and as investors seek more control and are beginning to search for innovative transparency in their investments. products, with a growing interest in18 The Future of Alternative Investments© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International.KPMG International provides no client services. All rights reserved.

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