Why Alternatives Outperform in Unusual Times

A fascinating conversation on an ever-more-vital asset class, with three thought leaders in the alternatives industry.

Under the aegis of his organization, the Real Estate Limited Partner Institute (RELPI ), CEO?Jonathan Schein ?held a roundtable with?Gila Cohen , Global Head of Institutional Partnerships?for Monroe Capital — and Strategic Advisor to MUFG Investor Services — and?Lorelei Graye , President of?the?Private Capital Data Standards Alliance?(PCDS ), a nonprofit industry organization focused on standardizing and optimizing reporting in this dynamic asset class.

A growth juggernaut

There’s no stopping the alternatives market — and there’s no ignoring it, either. According to private-capital research firm Preqin , alternative assets under management (AUM) are primed to exceed $17 trillion by 2025 — a compound annual growth rate of 9.8%, and one that far surpasses both global GDP and inflation. In the U.S. alone, there are six times more private than public companies with over $100 million in annual revenue.

?There are 6x more $100M+ private companies than public companies in the U.S.

By their very nature, alternatives such as private equity, private debt and real estate often exhibit a high degree of noncorrelation to external events, the most recent example being their outperformance during the COVID-19 pandemic. With this kind of resilience and growth — not to mention, the vast amounts of dry-powder capital seeking opportunity — it’s never been more important to understand the dynamic ways private markets are touching investors, including the growing number of institutional investors flooding the market in search of long-term returns.

An asset class driven by human intelligence — not algorithms?

Jonathan: Alternatives have performed incredibly well during the pandemic. With assets under management at record highs — and predictions of continued robust growth for the next five years — it makes sense to ask: what is it about this asset class that makes it so resilient?

Gila: More than any other asset class, alternatives are driven not by algorithms but by intelligence — human intelligence — which is another way of saying agility and creativity in the face of uncertainty or technological breakthroughs. Look no further than the outperformance of private equity and real estate in these pandemic years for evidence of that.

Lorelei: Absolutely. And I think it comes down to a simple fact: in private markets, disruption is opportunity. While COVID has been a human and global health crisis, from a strictly investment and business perspective, it’s a disruption. And in inefficient markets like ours, disruption, limitations, exclusivity, access, network — all of these create an opportunity set.?

?“In private capital markets, disruption is opportunity.” (Lorelei Graye)

Gila: It’s not just the pandemic, of course. This is an asset class that seeks and finds strategies and value in emerging trends — from bitcoin and blockchain to 3D printers, new ESG standards, and more. There’s no doubt in my mind that private markets are the wave of the future.

Standardization is key to unleashing private markets’ full potential

?Jonathan: If alternatives are doing great for investors already because they thrive on disruption and hidden opportunity, then why are standardization, benchmarking, transparency, etc., suddenly so important?

Gila: In large part, it’s due to institutions. With pricing so tight in conventional markets, even traditional institutions are seeking to break into alternatives, at scale. And as they do, they’re also driving the need for standardization, because they need to benchmark and account for it. They want to be able to look at the alternatives in their portfolio in a digitized format — using PCDS and ILPA and the new ESG standards — and evaluate how they stack up against their other assets (which are valued on a daily basis). That's been the biggest obstacle for them so far.

When that kind of standardization becomes commonplace — and companies like MUFG Investor Services, U.S . will be able to digitize those feeds, standardize them, and give them back to you in a way where you can compare them to your daily NAV, like hedge fund positions — you’re going to see a big breakthrough in alternatives. Everybody is looking for ways to deploy capital into the private markets — especially larger asset managers, who believe they will find more value and at a much faster pace.

Jonathan: Lorelei, you’re known as a pioneer for your work with PCDS. What drove you to start this organization?

Lorelei: Even under the best of conditions, alternative investment fund accounting in its current state is complex, time-consuming, and less than scalable. The global pandemic only sharpened those issues.?

“When standardization becomes commonplace, you’re going to see a big breakthrough in alternatives.” (Gila Cohen)

One of the major inefficiencies we deal with is in the data-exchange operation — notably time-to-information — between general partners and limited partners. That’s a constant stress point: it costs everyone more, and the opacity around the process can unnecessarily give potential investors pause. I realized that what we need is an independent, noncommercial body that can bring all the participants together and come up with a common technical language for accurate data exchange in electronic reporting.

We already have lots of momentum — nearly everybody wants the opportunity to access data on a level playing field. We’re working on the first draft of the data standards, which we expect to bring forward this year for comment from industry experts.

“The data-exchange operation is a constant stress point. I realized we needed a common technical language for electronic reporting.” (Lorelei Graye)

Good firms that provide the services and technology are going to differentiate themselves by going beyond accessing the information — and showing how they can make it useful.

Jonathan: For private equity, though, I can imagine there’s a little bit of heartburn around standardization (not to mention, regulation), to go along with all that growth potential. Is there a perceived risk in killing the proverbial goose with the golden egg??

Gila: I think, for the industry, there’s definitely a push-pull when it comes to standardization. On the one hand, the opaque structure of the market continues to benefit from the traditional operating model. On the other, they’re very eager to grow and expand — and they can't do that without institutional cash.

Institutions, for their part, are saying, “If you want us to invest with you, we need to be able to understand and explain your reporting to our shareholders. It needs to fit into our board packages — and you're going to have to bridge that gap. And by the way, with the SEC bearing down on the industry, it’s going to be increasingly hard not to.”

Lorelei: Yes, exactly. I’m hearing plenty of rumblings right now around trust and transparency in the markets. The SEC chair, Gary Gensler, has been quite vocal about private-fund disclosures to investors, and I understand the Commission may be already at work on some changes.

Gila: This industry lags significantly in regulation, standardization and oversight, and the government's catching up. So the onus is upon us in the private markets — who think about sector-specific, who think about asset classes, who work in those spaces — to figure out ways to catapult ahead on best practices and standardization. As the market grows, we want it to continue to be a shining place where new investors will want to jump on the bandwagon.

Look for Part 2 (coming soon)?of our discussion with these thought leaders, where we discuss the central role of relationships in driving this asset class, the growing prominence of women in senior executive roles in the industry — and why there’s (plenty of) room for more.