The markets woes will force investors, for the first time in nearly a decade, to really understand whats going on in their portfolios, making them distinguish between truly high-alpha strategies and strategies that are low alpha, but amplified through leverage, said Ronald OHanley, CEO of BNY Mellon Asset Management, Boston.
I think youll see a lot of strategies, and maybe even some firms, ultimately just go away, he said.
That reappraisal could be a long-term affair.
After enjoying the easiest conditions portions of the hedge fund and private equity worlds are likely to be see for the next 100 years, institutional clients are only in the very early stages of reassessing the outlook for those asset classes, said Jeremy Grantham, CEO of GMO LLC, Boston.
In some cases, clients could well conclude that real talent among hedge fund and private equity managers is relatively scarce, and that if you hire a median hedge fund manager all you have is a license to pay high fees and take a lot of risk, he said.
We expect all sorts of alternative assets to persevere, although the universe of managers will certainly narrow and the rules of the game (as regulators move to add new arrows to their quivers) will change, said Celia Dallas, director of published research with Cambridge Associates LLC, Boston.
And while the high octane may be spilling out of the private equity engine now, observers note that private equity managers are moving quickly to take advantage of the markets dislocations. A record number of distressed debt and mezzanine funds are being raised to capture the opportunities left by buyout fund transactions that are faltering, said Marc E. Friedberg, managing director of consulting firm Wilshire Associates Inc., Santa Monica, Calif.
According to London-based Private Equity Intelligence Ltd., 27 distressed debt vehicles are looking to raise $28.5 billion worldwide so far this year. For all of 2007, $35 billion was raised by 19 funds, an increase of 169% from the year before.
Other investment products are facing bigger questions.
The very existence of all of the packaged, sliced and diced stuff thats been floating around, such as collateralized debt or loan obligations, could be in doubt, noted GMOs Mr. Grantham.
Will Braman, CEO of Fortis Investments, Boston, which has a CDO division, said structured credit instruments wont go away. Still, he added, managers of these securities could face a year or two of consolidation, during which the attention of sponsoring firms will shift to opportunities in areas such as distressed debt.
Mr. Grantham said the markets current retreat could prove a spine-jarring speed bump, prompting quite a few investment committees to shave two or three points off of their targeted allocations to alternatives. Even so, those targets remain well above those institutions current allocations, he said.
Meanwhile, questions about counterparty risk, heightened by the recent government-led rescue of Bear Stearns Cos. Inc., New York, have hit a wide variety of fixed-income strategies that use credit derivative swaps and options, noted Fortis Mr. Braman.
There are more buyers of protection today than sellers, so the cost of protection continues to rise, pressuring investment returns, said David T. Kilborn, chief investment officer of fixed-income manager Dwight Asset Management Co., a Burlington, Vt., fixed-income manager.
Questions of counterparty risk are affecting 130/30 managers as well, with those who relied on one prime broker to source the equities they need moving to forge additional relationships, some market veterans said.
The benefits of access to a wider inventory of stocks have to be weighed against potentially having to pay higher fees for giving smaller chunks of your business as well as being lower on the totem pole for other strategic services prime brokers provide, said Russ Kamp, CEO of Invesco Quantitative Strategies in New York.
Fixed-income and 130/30 managers predict theyll come out of the current market squalls stronger.
The market is ringing excess out of the system, returning to a place where bonds arent overvalued just because theyve been levered, said Mr. Kilborn.