Traditional money managers are stepping up the pace when it comes to buying stakes in alternative investment firms, particularly private equity and real estate managers.
The reasons: More institutional investors are allocating to private markets, and managers that are courting those investors also are seeking to diversify their revenue streams.
“We've been in, and are projected to stay in, a low-growth world, so investors need alternative sources of alpha,” said Joseph Sullivan, CEO of Baltimore-based Legg Mason (LM) Inc. (LM) “The traditional equity and fixed-income returns aren't expected to meet the demands of investors. So private equity and real estate strategies are increasingly becoming mainstream.”
Earlier this year, Legg Mason bought a majority stake in real estate investment specialist Clarion Partners.
Other recent deals include OM Asset Management agreeing in June to acquire a majority interest in Landmark Partners, a secondary private equity, real estate and real asset firm.
And Neuberger Berman Group LLC's private equity subsidiary, Dyal Capital Partners, which buys minority stakes in alternative money managers with a focus on hedge funds, has recently increased its private equity acquisitions focus.
Last year, Dyal Capital acquired minority equity stakes in private equity firms Silver Lake, Starwood Capital Group and KPS Capital Partners.
“For most of my career, there has been little interest in acquiring private equity-style capabilities by money managers,” said Domonkos L. Koltai, a partner and co-founder of investment bank PL Advisors, New York. “But now, real estate, infrastructure, private debt and even straight private equity strategies are very much in vogue.”
Public plans allocated 26% to alternatives in 2015, up from 18.5% in 2010, according to Pensions & Investments data of the nation's largest retirement plans. Meanwhile, the typical corporate plan allocated 19.8% to alternatives in 2015 up from 17.4% in 2010.
Added Jeffrey B. Stakel, a principal at Casey Quirk by Deloitte in Darien, Conn.: “It's been a low-yield environment, which is driving people to more esoteric strategies, and that will continue for a while. Private strategies can take advantage of illiquidity premiums and deliver returns that traditional strategies can't.”
With traditional active management strategies unable to provide significant alpha, more asset owners are turning to private equity to achieve returns.
Coller Capital's Winter Barometer survey released in December showed 39% of investors expect to increase their private equity allocations. Over the past year, several plans — such as the Alaska Permanent Fund Corp., Maryland State Retirement & Pension System, North Dakota State Investment Board, South Carolina Retirement System Investment Commission, and Rhode Island State Investment Commission — have upped their allocations to private equity.
Private equity represents a growing and diversifying revenue base.
Peter Bain, president and CEO of OM Asset Management, said in a phone interview that when looking to build the business, he and other senior executives examined which asset classes OMAM needed.
Mr. Bain said he is conservative in regard to long-only fixed income and felt the business was already quite strong in equity; that left alternative asset classes. “So we looked at long-only hedge funds, fund of hedge funds and illiquid alts,” he said.
Because hedge funds haven't delivered over the recent past and it's unclear if funds of funds are going to turn into a traditional pooled model or separate account model, illiquid alternatives, which includes private equity, were the next logical choice, he said.
From a strategic standpoint, Landmark Partners had everything that OMAM wanted. “I think private equity will benefit from decent industry tailwinds,” Mr. Bain said. “Also, it can demonstrate a real process that can deliver alpha over a full market cycle.”
Mr. Bain added that OMAM is “continuing to look hard at the private equity segment” as it implements M&A.
Legg Mason (LM)'s Mr. Sullivan said his company bought Clarion because senior executives wanted to both expand the firm's investment capabilities for its clients — specifically by adding real estate to its wheelhouse — and also provide a diversified source of revenue for Legg's shareholders.
Mr. Sullivan said he thinks for the larger, more full-service managers, the trend will most likely increase. “Do I think these larger managers will seek out private equity capabilities? Yes. For the smaller boutique managers? No,” Mr. Sullivan said.
This article originally appeared in the January 9, 2017 print issue as, "Traditional managers snapping up stakes in alternatives firms".