Allocating to co-investments (which requires sophisticated governance and an effort to avoid adverse selection issues), backing fledgling managers, or creating bespoke partnerships with a few favoured businesses are some of the ways investors can reduce costs. Despite some eye-wateringly expensive fees, those investment trusts that are the listed versions of private equity funds are also benefitting from this flood of capital.
There has been record issuance this year. Often management and performance fees are charged at the trust-level, with another layer of management and performance fees in most of the underlying limited partnerships and secondary deals. That is before one even attempts to calculate fund operating expenses. The associated performance drag seems to be overcome only by adding still more leverage. Caveat emptor.
Liquidity and access
Offshore hedge funds now frequently provide a range of share class liquidity options with corresponding fee breaks for accepting lock-ins. Weekly or daily liquidity is now available from funds that are very similar to hedge funds, with many such funds running identically to a hedge fund operated by the same manager, with fund fees getting more competitive.
Investors looking at unquoted equity investments on, for example, fintech platforms, will likely have seen increased liquidity in recent years, but the liquidity is still limited compared to the public markets.
Diversification
As well as trading at historically high levels, many global equity indices are weighted according to market capitalisation, meaning portfolios are skewed towards the largest public companies with little consideration to industry and geographical exposure.
This means investors who in particular are focused on passive instruments are exposed to the performance of a relatively small number of equities, even if they own a number of different passive funds.
Conversely, alternatives are typically underrepresented in many portfolios (defined contribution pensions being a good example). Without the associated plethora of exchange-traded funds and other passive investments in many alternative asset classes, there are greater inefficiencies for skilled active managers to exploit, and it is much more likely that the portfolios to which a client is exposed will be diversified, not just from the listed markets as a whole, but from each other.
The resulting pattern of expected returns is diversifying from core equities and bonds. Alternative credit, such as high-yield bonds, securitised credit, and emerging market debt offer some attractive diversification characteristics, usually with shorter duration than investment grade and government bond markets.
Shorter duration bonds are those that will reach their maturity soon, and so investors are less exposed to factors that can impact returns in other equity and bond investments.
