Although the alternative assets industry surpassed $10 trillion for the first time in 2019, with an increase of more than $700 billion in just the first half of the year, the future of the industry “looks increasingly challenging,” according to financial data and information provider Preqin.
A new report from Preqin said that while fund managers have benefited from a large influx of capital from investors combined with strong long-term performance, high asset pricing is compressing future returns in most private capital asset classes.
“We observed that financial markets were at a watershed moment, with high asset valuations, economic and political uncertainty, and a challenging period for investment returns ahead,” Mark O’Hare, CEO of Preqin, said in a statement. “Global markets have continued their upwards path, and the outlook is certainly challenging. Alternative assets have a good track record of delivering for their investors, but if they are to continue to do so, it will need to adapt and evolve in response to market challenges and opportunities.”
Hedge fund managers saw “a much-needed recovery” in 2019 as the industry rebounded from losses of 3.06% in 2018 to return 11.45% over the year. Assets under management (AUM) rose 4.6% compared with the previous year to reach $3.61 trillion as of November, which is the highest point since the third quarter of 2018 ($3.62 trillion).
However, 40% of hedge fund investors Preqin surveyed in November said the performance did not live up to expectations, even though 2019’s performance was only the second time industry returns were in the double digits over the past six years.
The report also said there are some “clear warning signs for the industry,” noting that investors withdrew a net $82 billion from hedge funds in the year to November, which marks the worst year for redemptions since $110 billion was taken out in 2016. It also said net outflows occurred in every major region.
“Shifting investor sentiment also made the market more challenging for new launches,” said the report, as only 529 hedge funds launched in 2019. That’s less than half the number launched in 2018 (1,169) and was the seventh straight year of decline. And liquidations outpaced new funds entering the market, reducing the number of active funds in the industry to 16,256.
Meanwhile capital flows into global private equity were strong in 2019 as investors sought out higher yields to compensate for the lowest gross domestic product (GDP) growth since the global financial crisis and persistently low interest rates. Investors continued to flock to private equity funds, committing more than $500 billion and boosting fund managers’ stockpile of dry powder. The growth in available capital, coupled with an 11% rise in unrealized value, increased assets under management to a record $4.11 trillion as of June.
“However, market conditions are becoming more difficult,” the report said, pointing out that the influx of investable capital and intensifying competition have spurred an increase in asset prices. According to the report, 51% of fund managers and more than 69% of investors said they feel that private equity portfolio company prices are higher compared with 12 months ago. And 44% of fund managers experienced more competition for private equity transactions.
“All this has had a dampening effect on deal flow,” said Preqin, as the value of all private equity-backed buyout deals fell 21% to $389 billion between 2018 and 2019, while venture capital deal value declined by 18% to $223 billion.
Additionally 45% of private equity fund managers said they expect a correction in 2020, and three-quarters believe a shift in investor focus from public markets to private investment will impact private equity.
While the report found challenges facing the hedge fund and private equity industry, the private debt market kept marching on with assets under management hitting a record again with $812 billion as of June. Private debt is now the third-largest asset class in private capital, ahead of infrastructure and natural resources.
“Looking ahead, investors are upbeat about their private debt portfolios,” the report said. “A significant 91% of investors we spoke to will either maintain or increase their allocation to private debt over the longer term.”