Enrique Suarez Presenting:
Alternative Investments 2020
The Future of Alternative Investments
World Economic Forum
This report examines the forces driving today’s alternative investment industry and considers where these may take the industry in the coming years, focusing on the core asset classes of private equity buyouts, hedge funds and venture capital. Alternative investment has matured over the last 30 years and is gradually becoming part of the mainstream financial industry, garnering greater attention and acceptance from both regulators and the general public. However, it is also entering a period of considerable growth and change due to the influence of macroeconomic drivers, post-crisis financial industry regulation, and two critical industry trends: the increasing sophistication of institutional investors and the rise of retail investors as an important source of capital.
The most fundamental macroeconomic driver is the rise of emerging market economies. They generate new investment opportunities and serve as an increasingly important source of capital. At the moment, most emerging market capital flows into alternatives via sovereign wealth funds (SWFs), but the growing number of high net worth individuals in emerging markets – and their openness to alternative investing – will soon become important.
Demographics in the developed world are also critical, as the rising tide of pensioners is leading to a growing funding gap in retirement systems. With the leading central banks likely to keep benchmark interest rates near zero for the foreseeable future – ensuring low returns from fixed-income investments – many pension funds are increasing their allocations to higher return alternative investments.
Meanwhile, post-crisis regulatory reforms intended to improve the stability of the global financial system are creating both challenges and opportunities for alternative investors. Bank capital, liquidity and collateralization reforms have discouraged banks from holding many alternative assets on their books and from lending short-term money to fund some alternative investments (e.g. hedge fund strategies). New regulations aimed directly at the investment and alternatives industry are also requiring firms to improve their infrastructure, transparency and reporting and are speeding up the maturation of the industry. However, the cost and complexity of the new laws is creating barriers to entry for the industry which may reduce innovation in ways that drag down the long-term returns available to investors critical to society, such as pension funds.
Institutional investors are presently the main supplier of capital for alternatives, and their growing confidence and investment capabilities after investing over multiple economic cycles – a complex phenomenon known as “institutionalization” – is a key driver of many future trends in the industry. The process has helped to increase both the size of the industry and its importance to wider society. However, an even more fundamental change in the retirement sector, the shift from defined benefit to defined contribution pensions (where investments are controlled by individuals), may lead to a significant influx of retail capital into the alternatives sector.
This “retailization” trend will be a key driver of growth in the alternatives industry in coming decades, and not just for the current incumbents. Traditional financial services, led by asset managers and banks, will also dramatically expand revenue streams associated with providing access to alternative investments or related products. In turn, regulators will face the challenge of crafting laws that protect investors from unwise investments, while still permitting them to access the returns and diversification benefits associated with alternative products.
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