Devising a new liquidity paradigm
31 Aug 2022
Asset managers are establishing fund ranges that offer clients access to both liquid and illiquid strategies. While unlocking commercial opportunities, moving up and down the liquidity spectrum can create operational complexities, outlines RBC Investor & Treasury Services’ Craig Williams
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To diversify returns and appeal to new groups of investors, traditional and alternative asset management firms are launching an ever-wider gamut of fund strategies. The offerings are often far removed from their original flagship products. This sort of hybridisation or convergence can be quite appealing for fund managers, but only if the offerings are on-boarded and administered correctly.
Illiquidity correlates with better returns
Frustrated by market volatility and soaring inflation, a number of long-only managers are now looking to capture the illiquidity upside by establishing private funds. Private markets have delivered significant returns over the last decade.
Take private equity, which generated a pooled internal rate in return of 27 per cent in 2021, making it one of the best-performing asset classes in the private markets universe, according to Mckinsey’s Global Private Markets Review 2022, published in March. McKinsey’s Review also found that at the same time, private debt — owing to its diverse range of sub-strategies — has proven resilient amid the various macro headwinds.
A lot of the major traditional players are looking to optimise their returns by developing multi-asset private capital solutions, whether it be private equity, infrastructure, private debt, or real estate. Conversely, some private capital managers are further diversifying their offerings by setting up alternative investment schemes that include different fund and corporate structures.
The foundations for a larger investor base
Hybridisation can be a useful tool for asset managers to attract clients, irrespective of their liquidity profile. For instance, there is a growing legion of private capital managers that are manufacturing more liquid products as they look to tap into the retail and affluent investor market; this is in addition to their more traditional institutional clients.
Other managers are developing investment vehicles that lie somewhere in the middle of the liquidity spectrum. Examples include open-ended funds with monthly or quarterly liquidity terms, or closed-ended funds with limited redemption windows, according to Schroders’ Democratisation of Private Assets, published 15 March 2022.
Rising interest rates and inflation — along with some of the other global geo-political challenges — are prompting investors to ask for greater liquidity in their fund structures. We see these requirements in the funds that we are onboarding.
Hybridisation unleashes operational complexity
While hybridisation has many benefits, managers do need to be aware that transitioning into new strategies can bring about operational challenges.
Long-only managers moving into private markets, for example, are likely to find themselves dealing with unfamiliar practices such as carried interest calculations and distribution waterfalls. In contrast, private capital firms building a more retail-orientated product will need to come to grips with unfamiliar distribution channels and liquidity structures.
Typically, private capital firms will have commercial relationships with just a handful of large clients, but retailisation could result in this becoming thousands of clients accompanied by a reliance on key distributors.
Onboarding such a large number of retail investors, while simultaneously conducting due diligence on each of them, is likely to be a significant logistical undertaking.
Asset managers will need to address these challenges, either by hiring the right people internally or working with suitable third parties such as distributors, depositaries, custodians, and administrators. To ensure liquidity, private capital funds may need to obtain credit lines from their banks or hold surplus cash to meet client redemption demands in some of their more liquid structures.
Outsourcing is one way to navigate hybridisation
Outsourcing is one way for managers to navigate the challenges of hybridisation.
As managers’ operational requirements become increasingly complicated, many are having to invest in their internal systems and processes.
Alternatively, some firms are turning to third-party vendors for support, due to consideration of the added operational costs in the current inflationary environment, or simply because they are unable to recruit talent owing to the chronic labour shortages.
Managers running multiple strategies need to be selective when choosing their vendors and ensure that service providers can support them across multiple asset classes, whether it be open-ended, quasi-open-ended, or closed-ended fund structures.
Illiquidity correlates with better returns
Frustrated by market volatility and soaring inflation, a number of long-only managers are now looking to capture the illiquidity upside by establishing private funds. Private markets have delivered significant returns over the last decade.
Take private equity, which generated a pooled internal rate in return of 27 per cent in 2021, making it one of the best-performing asset classes in the private markets universe, according to Mckinsey’s Global Private Markets Review 2022, published in March. McKinsey’s Review also found that at the same time, private debt — owing to its diverse range of sub-strategies — has proven resilient amid the various macro headwinds.
A lot of the major traditional players are looking to optimise their returns by developing multi-asset private capital solutions, whether it be private equity, infrastructure, private debt, or real estate. Conversely, some private capital managers are further diversifying their offerings by setting up alternative investment schemes that include different fund and corporate structures.
The foundations for a larger investor base
Hybridisation can be a useful tool for asset managers to attract clients, irrespective of their liquidity profile. For instance, there is a growing legion of private capital managers that are manufacturing more liquid products as they look to tap into the retail and affluent investor market; this is in addition to their more traditional institutional clients.
Other managers are developing investment vehicles that lie somewhere in the middle of the liquidity spectrum. Examples include open-ended funds with monthly or quarterly liquidity terms, or closed-ended funds with limited redemption windows, according to Schroders’ Democratisation of Private Assets, published 15 March 2022.
Rising interest rates and inflation — along with some of the other global geo-political challenges — are prompting investors to ask for greater liquidity in their fund structures. We see these requirements in the funds that we are onboarding.
Hybridisation unleashes operational complexity
While hybridisation has many benefits, managers do need to be aware that transitioning into new strategies can bring about operational challenges.
Long-only managers moving into private markets, for example, are likely to find themselves dealing with unfamiliar practices such as carried interest calculations and distribution waterfalls. In contrast, private capital firms building a more retail-orientated product will need to come to grips with unfamiliar distribution channels and liquidity structures.
Typically, private capital firms will have commercial relationships with just a handful of large clients, but retailisation could result in this becoming thousands of clients accompanied by a reliance on key distributors.
Onboarding such a large number of retail investors, while simultaneously conducting due diligence on each of them, is likely to be a significant logistical undertaking.
Asset managers will need to address these challenges, either by hiring the right people internally or working with suitable third parties such as distributors, depositaries, custodians, and administrators. To ensure liquidity, private capital funds may need to obtain credit lines from their banks or hold surplus cash to meet client redemption demands in some of their more liquid structures.
Outsourcing is one way to navigate hybridisation
Outsourcing is one way for managers to navigate the challenges of hybridisation.
As managers’ operational requirements become increasingly complicated, many are having to invest in their internal systems and processes.
Alternatively, some firms are turning to third-party vendors for support, due to consideration of the added operational costs in the current inflationary environment, or simply because they are unable to recruit talent owing to the chronic labour shortages.
Managers running multiple strategies need to be selective when choosing their vendors and ensure that service providers can support them across multiple asset classes, whether it be open-ended, quasi-open-ended, or closed-ended fund structures.
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