Private credit is a new front in alternatives turf war: survey

In their escalating competition for investor cash, private equity and hedge fund managers are converging on similar strategies, like private credit, according to a recent survey.

Investors, as a whole, prefer private equity to hedge funds, but the demand for diversification and customized strategies has opened up new ground for competition, according to Ernst & Young’s 2018 Global Alternative Fund Survey. The firm surveyed more than 200 managers and 60 investors, and found that the lines between hedge funds and private equity managers are blurring as both attempt to meet investor demand for nontraditional offerings such as private credit, real estate and real assets.

“Whether it be competing product offerings, utilization of similar technology or demand for the same talent, hedge funds and private equity funds, as well as other alternative managers, are more frequently stepping on each other’s turf, resulting in the entire alternatives community competing against each other,” Ernst & Young found. “The fierce competition for assets has resulted in two formerly distinct types of managers offering competing products to the same customer.”

Private credit is a significant and growing portion of investors’ alternatives portfolios, with a current aggregate allocation of 9 percent.

It is also an area where both hedge funds and private equity managers feel they can compete, according to Ernst & Young. Both industries are attempting to extend their investment capabilities and operational infrastructure to tap into investor appetite for private credit. Private equity and hedge funds are also experimenting with other alternative offerings including real estate and real assets.

Private equity might have an edge in the private credit arena as well, since PE managers are more receptive to new strategies and products than their hedge fund peers, according to the survey.

Nearly 60 percent private equity managers are using new products to grow their assets, while 55 percent of hedge fund managers say they are only focused on their existing strategy to grow their asset base, according to the survey. Private equity firms are significantly outpacing hedge funds in bringing credit, real estate, real assets, business development companies and venture capital strategies to market, according to the survey.

Among the investors surveyed, hedge funds had a higher share of alternative asset allocation than private equity. The surveyed investors had allocated 40 percent of their alternative assets under management to hedge funds, and just 18 percent to private equity.

But those same investors are more optimistic about private equity – 34 percent of investors plan to increase their PE allocations within the next three years, while just 9 percent said they planned to decrease their target allocations.

Hedge funds, on the other hand, are less in demand – 21 percent of surveyed investors said they plan to decrease their hedge fund allocations, while just 7 percent plan to increase allocations.

Hedge funds have had lackluster returns relative to their costs, and hedge fund managers of all sizes have reported coming in far below their fundraising targets over the past 12 months, according to Ernst & Young.

Private equity managers had had no trouble raising capital, and two in three private equity managers who are launching new funds expect those pools to increase in size from prior raises, according to the survey.

Action Item: Read the full survey here https://go.ey.com/2RCIsZX