Alternative investments are likely to contribute up to 40% of the global asset management industry’s revenues by 2020, according to McKinsey & Co.
The now-$7.2 trillion sector is likely to balloon to make up about 15%, or $14.7 trillion, of total industry assets over the next five years, the consulting firm said.
The report claimed the rapid growth goes beyond investors’ chase for returns and is rather driven by “powerful structural forces” that institutional investors face: Asset owners now seek consistent and uncorrelated risk-adjusted returns from alternatives.
“Structural, rather than cyclical, forces are accelerating the adoption of alternatives, chief among them the linking of alternatives to critical investment outcomes—a phenomenon that takes the value of alternatives strategies ‘beyond alpha’,” the report said.
According to McKinsey, investors have become “disillusioned” by traditional asset classes as long-only strategies face challenges in the uncertain interest rate environment. Instead investors have been increasingly adopting risk-factor strategies that utilize alternatives as a central part of portfolios. They are also anticipating alternatives to target and deliver a “range of solutions” customized for their portfolio, such as inflation-protected income or a hedge against volatility.
“Structural, rather than cyclical, forces are accelerating the adoption of alternatives, chief among them the linking of alternatives to critical investment outcomes—a phenomenon that takes the value of alternatives strategies ‘beyond alpha’,” McKinsey said.
The report found certain investors, especially defined benefit pension plans, were allocating to more to alternatives “out of desperation rather than desire,” to match asset-liability gaps and endure low funding ratios.
McKinsey predicted alternatives would comprise an average of 26.2% of total portfolio assets by the end of 2016, up from 25.1% in 2013. Large institutions with at least $10 billion in assets could see alternative allocations exceed 29% by 2016, the report said.
As a variety of investors spill into alternative investments, the report said a range of asset management firms have picked up the gauntlet and tailored services to clients' needs.
Single-strategy boutiques, offering innovation through high-conviction strategies, and specialist alternatives platforms that provide focused excellence in a single asset class or strategy may present most value to large institutions “seeking a performance edge,” the report said.
Smaller or newer investors are more likely to look for multi-alternative mega firms with “industrial-strength capabilities” across a range of strategies, asset classes, and regions, McKinsey argued. Diversified asset managers, or one-stop shops, could also help smaller institutions better incorporate alternatives into the larger portfolio.
However, such “mainstreaming” of alternatives and the rise of a variety of managers have also caused a “trillion-dollar convergence” in asset managers, according to McKinsey.
“Leading hedge funds, private equity firms, and traditional asset managers, which to date have occupied distinct niches in the investment management landscape, will increasingly battle for an overlapping set of client and product opportunities in the growing alternatives market,” the report said.
The report was based on the polling of nearly 300 institutional investors with $2.7 trillion in total assets.
Related Content: Alt Managers: Who’s Up (Blackstone) and Who’s Down, Are Alternatives Still an Asset Class?