By Bill Kelly, CEO, CAIA Association
In the world of cinema, by most accounts, it is The Godfather Part II that holds the top spot for best movie prequel. Interestingly, by design and title, it is also a sequel. Sequels at the box office are often panned but this production was an impressive exception to the rule as it took the honor for Best Picture in 1974. Perhaps it was the prequel-based plot that made this sequel such a success.
It is hard not to draw some of these same parallels when reading the recent report from Preqin, The Future of Alternatives. The backstory plot of alternatives is a good one. As the more traditional markets became increasingly efficient, the alpha hunters turned their attention to the less covered, less liquid, and by default, the more inefficient corners of the market. The most sophisticated endowments and sovereign wealth funds caught this wave very early on, but it was not until the late 1990s that broad institutional adoption of asset classes such as hedge funds, commodities, private capital and real assets started to take a meaningful role in the asset allocation model portfolio. Not surprisingly, this was when the CISDM at The Isenberg School of Management and AIMA hatched the very fortuitous plan to bring professionalism and investor education to this space, and so the CAIA Association was born.
The sequel part of this story has all the makings of a thriller. Preqin is forecasting an overall asset growth rate of +59% by 2023 with each individual asset class growing by 30% or more; on the lower end you will find the maturing hedge fund space, ballasted against a +300% expectation in the case of natural resources. The story is equally compelling beyond just asset classes. By geography, the powerful forces and sheer size of the Asia Pacific and African markets are expected to arrive in a big way with China leading that charge. The public pension plan space is also expected to move more toward the deep end of the pool as the dominant source of anticipated capital moving into this space. The importance of ESG-based mandates is also covered with much higher levels of expectation in the period ahead. The report also touches upon the rapidly increasing relevancy of artificial intelligence and machine learning, the raison d’être for the CADA Institute.
On a disappointing note, the subject of diversity (or lack thereof) in our industry remains largely aspirational and it is hard to reconcile the fact that almost two thirds of the surveyed fund managers have indicated that they have no diversity policy in place and no plans afoot to change that. The Fearless Girl is watching, and we cannot accept this status quo, even when selecting a pic for a seemingly routine blog post.
All of this brings us back to the prequel part of this story. The journey into alternatives in the first place was really AllAboutAlpha. That forest is now expected to have 34,000 fund management firms (the alpha hunters) by 2023 and they do run the risk of cannibalizing the very reason why they are there in the first place. There are clearly alpha opportunities to be had, but more hunters bring more efficiencies and soon we may end up with a lot more commoditized beta, or perhaps in the case of the private capital markets, a very skinny asset class premium over any public market proxy. Embrace this future and the clear opportunities that it can bring but take along some lessons of the past. Accessing simply named asset classes will not work as this industry grows and matures. Performance dispersion will widen significantly along with this growth and good old fashioned IDD and ODD, in the words of The Godfather Don Corleone, must always be the “offer you can’t refuse.”
Seek diversification, education and know your risk tolerance. Investing is for the long term.