Why No Alternatives for Retail?
New Year, same issues for alternative investment funds it seems. The latest survey from the European Securities and Markets Authority (ESMA), basically a health check on all of the EU’s Alternative Investment Funds (AIFs), has some interesting stories to tell. The sector as a whole – based on NAV – is worth €5.4 trillion and amounts to 40% of the total fund industry for the EU. That is considerable, and paints these funds as becoming more mainstream than people may think.
However, that is both a blessing and a curse since fund of funds make up 14% of total, with Real Estate Funds at 12%, and Hedge Funds and Private Equity funds pegged evenly on 6% each. Other AIFs account for the remaining 61%, but it is in the Fund of Funds and Real Estate sectors that we see the highest proportion of retail investors. Overall, most AIFs are sold to professional investors, the survey states, with 84% of sales in this category. But that leaves a fairly significant 16% retail investor participation, and yes, the majority of those are in Fund of Funds and Real Estate, at 31% and 21% respectively of all investors in these sectors specifically.
Is this a problem? On the face of it, why should it be? Retail investors are allowed to put their hard-earned into these funds, but not into hedge funds because of the additional risks the latter are perceived to take. But liquidity in these retail-investor friendly funds is potentially more problematic than in hedge funds, according to ESMA, so perception is not closely aligned with reality. The ESMA survey states: “Many of the funds in the Real Estate sector offer daily liquidity, which indicates a structural vulnerability risk as they invest in illiquid assets while allowing investors to redeem their shares over a short time-frame. For the Funds of Funds sector there is a mismatch in liquidity, as 35% of the NAV is redeemable within a day, while only 24% of assets can be liquidated within that timeframe.” The Hedge Fund sector – which makes up €333 billion by NAV and 67% of the total exposure for the EU AIF sector as a whole thanks to derivative exposure in other funds – ironically has some additional elements of security because of the large cash buffers these funds maintain. Yet these are closed to retail investors because they are too risky. When it comes to understanding what level of risk an investor is taking, there is much more to consider than just the make up of the funds. The fact that retail investors make up relatively large proportions of the money going into FoFs and Real Estate funds should make these fund managers sleep a little less easy. Given the liquidity mismatch that has emerged in the funds retail investors can access, it begs the question as to why hedge funds – which ESMA freely states have larger cash buffers – are off limits? Surely, they should be considered acceptable to more sophisticated retail investors at least, since the risk profile of the funds they can access seems to have grown, perhaps even without those investors realising.
We’ve had experience of real estate funds being decimated in 2007 during the credit crunch, and it was brutal. The double-digit returns of property funds quickly turned to double-digit losses, with the stampede of investors being stemmed only by funds imposing restrictions on how investors could take their cash. The last thing we want is for something similar to happen in the coming years, with retail investors again fully in the crosshairs of a potential financial disaster.
