The report, released in November, was compiled from a survey of three sets of key players: long-only and alternative investment managers; pension funds; and administrators of long-only and alternative investments. Their responses have revealed three key trends.
The first is the convergence between long-only and alternative investments, as more participants in each are adopting the techniques of the other. Secondly, that between alternative investments themselves, with private equity managers and hedge funds becoming more closely aligned. Lastly, the convergence within asset classes, such as when a fund expands its portfolio into new regional markets. "Up to now, convergence has been tactical," says Jon Mills, a partner at KPMG. "Now it’s more about strategic measures."
Convergence, according to the report, is mainly being driven by the increased demand of clients for absolute returns, causing investment managers to look for new areas to find them. As hedge funds and private equity firms seek these returns with aggressive, more diversified investments, long-only managers have been forced to find ways to replicate those returns. Another driver for convergence by long-only managers is the need to retain talent. More and more hedge fund managers have come from long-only investors, and the balance is not being redressed. The need for talent is at or near the top of every investment manager’s priority list, and mimicking hedge fund strategies might stem the flow.
Although the credit crunch has perhaps slowed the rate of convergence, it has not stopped. Indeed, the combination of convergence and the present bear market has reportedly raised the prospects for faster consolidation of the investment industry. But there are other factors that might hamper convergence. The majority of managers at the moment are purists who believe those that have embraced convergence have done so in the misguided assumption that there is success to be had. Many long-only managers believe that success with new convergence tools is far from a given. One example is 130/30 funds. Although giving long-only managers the opportunity to short-sell seems like a great way for them to better express their views, some have highlighted that there seems to be very little obvious benefit to the investor.
Although there are questions about its ultimate success, convergence continues apace. Diversified strategies will enable investment managers to better retain talent, and consolidation will continue through M&A activity. Many pension funds have been diversifying in ways that have promoted convergence. The search for returns and the diversification of risk is causing investment managers to broaden their asset base. The opportunities for growth are huge. Although many pension funds might be put off by the thought of engaging in investment strategies outside their traditional sphere, it would not take much in terms of an increase in the allocation of pension fund investment to double the size of the hedge fund market. "In five years’ time," the KPMG report argues, "some alternative managers will be larger than the top investment banks."