New Survey Concludes Finding Alpha Is Difficult

By Christopher Faille

SEI (NASDAQ: SEIC), the international investment management concern, has released the second part of an ongoing 3-part series of research papers based on a survey of participants in the private equity markets.

Part 1, “The Logic of Fund Flows,” focused on who is investing in PE and why.

The newly released Part 2, “Searching for Alignment,” looks at the contrasting perspectives of PE investors on the one hand and managers on the other, especially with regard to transparency. It also discusses some of the concerns they share, among which is the scarcity of “quality investment opportunities.” That seems to mean: ways to get to alpha.

Part 2 opens citing a quarterly report from Triago, a PE placement agent founded in 1992. The report said that the net asset value of PE funds globally had by the end of 2010 returned to a point near the pre-crisis levels of the end of 2007.

Confidence has, to a degree, returned. This is so insofar as the graph below, from the SEI’s Part Two, shows that only 17 percent of investors in the survey said that they are concerned about their ability to exit their positions within the next year to 18 months.

Yet confidence continues to lag, as shown by another datum in the same graph. The most worrisome challenge, according to both investors and managers, is the scarcity of quality investment opportunities.  The consultants, the third group of interview subjects, are more worried about “economic uncertainty” than about that scarcity. But, then, consultants are paid to look at the Big Picture.

Transparency: Old and New

The SEI paper soon turns to the fraught issue of transparency. Eighty five percent of managers currently say that they give their investors all the information they need. Only 43 percent of investors say that they receive all the information they would like though, and only 10 percent of consultants say the same.

Part of this discrepancy may be attributed to the range of meanings of the word “transparency” itself. What SEI calls “traditional forms of transparency” consist of information “on exposure to sectors, large holdings, geography, and asset classes.” The less traditional but, for investors today, very desirable disclosures involve leverage, volatility statistics, and counterparty risks. Managers, in their belief that they are already providing everything their investors need to know, are “more focused on what they are already providing” than on “what investors need and want.”

The degree to which a fund is leveraged is the most highly sought-after type of risk information, according to investors and consultants, with volatility a (rather distant) second. Managers, on the other hand, record exposure by industry sector as the most important data.

Firms must make investments to take advantage of the opportunities presented them by the revival of investor interest. Among the plausible investments: back office operations and technology; the hiring of marketing and distribution personnel; investor reporting.

But the managers questioned said by a large margin that the most imperative area of investment for them in 2011 is the hiring of portfolio managing personnel. Compliance and regulatory systems came in second and portfolio management systems third.  Thus, portfolio management, in both its human and its digital components, takes up two places in the top three. This reflects the same truth reflected by other questions about the common worries of managers and investors – good investment opportunities, i.e. promising portfolio positions, are difficult to find. In short, finding alpha is tricky. And finding inadequately rewarded risk is all too easy.

The same quarterly report from Triago cited above on the return of net cash inflows also issued a caution about overhangs, which is quite pertinent to the concerns members of all three surveyed groups expressed in their interviews for SEI’s report. Triago warned that there remain significant overhangs, legacy investments made at the height of the credit bubble in the middle of the last decade. These overhangs hold “the bulk of private equity’s dry powder,” and their impact is the big question for the industry going forward.


SEI tells us: “With harrowing memories of the recent financial crisis still fresh, investors have understandably raised their expectations” and are “”more likely than ever to ask managers for evidence of the value they are meant to be providing in return for the fees being paid to them.”

There have been a variety of responses from the managers, and there is no easy formula for the alignment of interests. But SEI recommends a “service orientation.” And in the course of developing this orientation, the imperative of transparency stands out.

The whole series is based upon a survey of 411 market participants.

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