A new report by KPMG does not see a major trend of alternative investment funds leaving offshore financial centres,
but it recommends managers follow a dual strategy involving both offshore and onshore funds to attract European investors that are new to alternative investments.
The study “Transformation: The Future of Alternative Investments” finds that managers and administrators perceive regulation in response to the financial crisis and governance issues as the biggest challenges to the industry in the next three years.
However, investors do not believe that regulation is going to produce any tangible benefits, the report said.
On the contrary, the study’s surveyed respondents, which included more than 200 investment managers, fund administrators and institutional investors, expect regulation will add costs and bureaucratic burden and stifle creativity within the industry.
A specific threat from a Cayman perspective is that the alternative investment industry may, as a result of regulation such as the EU Alternative Investment Fund Manager directive, move away from offshore jurisdictions and relocate onshore.
Some managers have done so already, while others have launched funds in onshore locations, such as Dublin, Ireland, in addition to their offshore funds, the report said.
According to KPMG, however, 81 per cent of institutional investors indicated that domiciliation has little impact on their allocation decisions. Investors with longer tenures of investing in alternative investments tend to be the least concerned with fund domiciliation, the report said. “Managers would therefore be wise to maintain their offshore fund range for their bedrock investors,” KPMG concluded.
Those respondents who would prefer to allocate to funds that are domiciled onshore are typically new investors to alternative investments. This type of investor also insists on more liquidity and transparency, the report said. In order to attract this next wave of investor’s capital, managers should, at least in Europe, follow a dual strategy involving both onshore and offshore funds.
Although, alternative investment domiciliation is diverging, the traditional homes of the hedge fund and private equity industries are not under significant threat, according to KPMG.
“[Offshore jurisdictions] will continue to be the logical place to go for funds aimed at the traditional alternative investor,” the report said. “However, EU domiciles are developing complementary structures to compete for this business and appeal to the new generation of investors.”
“There’s an interesting distinction here and an important observation for the Cayman Islands,” said Wanda Mellaneo, a director with KPMG in the Cayman Islands and chair of the editorial team that produced the report. “While investors are clearly looking for products with increased transparency and liquidity, they do not seem to be demanding regulated products.
“Nor are they particularly concerned with the question of domicile, which runs counter to how much attention the onshore/offshore debate has attracted lately,” she said.
Overall the report concludes that changing demands from institutional investors are transforming the alternative investment industry. Following a number of high profile fraud cases, all survey participants stated that they now take a heightened interest in the back-office operations of alternative investment funds.
The traditional relationship between institutional investors and managers is evolving due to demands for increased transparency, liquidity, more extensive controls and flexible product strategies. This affects not only fee arrangements or servicing agreements but also the entire business model of alternative investment funds.
Anthony Cowell, partner at KPMG in the Cayman Islands and principal author of the report said: “Historically, anyone considering an investment in alternatives had to invest on the manager’s terms. Today, the picture of the industry has been turned on its head; it’s now one in which investors are firmly in the driving seat and, fundamentally, investors want to see managers’ interests more closely aligned with their own.”
As the majority of institutional investors intend to increase their allocations to alternative investments over the next three years, according to the report, their growing influence is not likely to wane.
Fund administrators are also affected by this transformation as demands for reporting transparency and liquidity requirements necessitate greater standardisation.
The need to provide ever more data to fund managers and regulators will require “robust and flexible technology platforms that are capable of high-volume transaction processing and customised ‘real-time’ reporting,” KPMG wrote.
For most administrators, who are operating at or near full capacity, this may raise serious infrastructure issue, the report said.
Andy Stepaniuk, head of alternative investments at KPMG in the Cayman Islands and co-author of the report, noted that there is also an emergence of a new breed of manager.
“Recently, we’ve seen the rise of the entrepreneurial-institutional (EI) manager; one that’s more formalised and offers clients multiple products (including complementary services like financing, private placements and proprietary trading, for example) through multiple distribution channels,” he said. “Despite their size, though, they seem to have managed the balance between the needs of a creative environment and the rigidity of the institutional infrastructure that investors are demanding.”