The asset management industry has undergone seismic shifts over the past few decades. What was once dominated by traditional long-only, benchmark-oriented strategies have given way to a proliferation of alternative investment approaches. This diversification of strategies reflects both the changing needs of investors as well as the drive for innovation within the industry.

The Rise of Alternatives

The term “alternative investments” encompasses a broad range of strategies that fall outside the traditional categories of stocks, bonds, and cash. ICMA noted that some of the most common alternatives include hedge funds, private equity, venture capital, real estate, and infrastructure. While these strategies have existed for decades, they really started to gain traction in institutional and high-net-worth portfolios in the 1990s and 2000s.

There are several interlinking factors behind the surge in interest in alternative investments. One is the search for diversification and ways to spread risk. The modern portfolio theory that has long guided asset allocation emphasizes the value of low correlated asset classes. Many alternatives offer returns that do not move in lockstep with traditional stocks and bonds, providing investors greater overall diversification.

The extremely low interest rate environment that has prevailed since the 2008 financial crisis has also made the hunt for yield more acute. Alternative strategies often target higher absolute returns or premiums over public market benchmarks. Especially during periods of low rates, these additional returns become even more appealing.

There has also been an ongoing drive by pension funds and other institutional investors to meet growing future liabilities. The longer time horizon and cash flow needs of pensions align well with the investment profiles of some private market alternatives like private equity and infrastructure. Consequently, allocations to alternatives have moved steadily upwards to help offset growing future obligations.

The Changing Manager Landscape

As strategic demand increased, the landscape of asset managers offering alternative solutions underwent dramatic change. Asset managers saw the growth opportunities early and moved quickly via acquisitions, lift-outs, and internal development to respond. Large multi-strategy firms that already had footholds in alternatives grew these capabilities aggressively. Specialist boutique managers also proliferated and themselves became acquisition targets.

At the same time, alternatives-only managers like Apollo, Blackstone, Carlyle and KKR have similarly diversified into areas like liquid credit and hedge fund solutions.

Well-established traditional managers expanded their solutions suites to include both liquid and illiquid alternative approaches. For example, major mutual fund companies like Fidelity, T. Rowe Price and Natixis IM have increased their alternative offerings. 

The surging interest also drove new product development. Alternative managers cultivated retail-friendly vehicles like ‘40 Act mutual funds, UCITS funds and interval funds to tap into the demand. Customized separate account vehicles were also created for large institutional investors. Overall, investors today have vastly more options and easier access when allocating to alternatives than ever before.

Ongoing Innovation

Innovation has also continued apace even amid the maturation of the alternative investment market. New strategies continue to be developed as managers identify additional niches or needs.

For example, private debt has been one of the fastest growing alternative categories in recent years. As post-crisis regulations limited bank lending, non-bank lenders like private debt funds helped fill this void. Investors benefited through enhanced fixed income diversification, higher yields, and low defaults. Private debt encompasses areas as diverse as distressed credit, specialty finance, royalties, infrastructure debt and more – each focusing on less efficient market segments.

ESG-oriented alternatives have also proliferated. As sustainable investing principles spread, managers are applying these concepts across real estate, infrastructure, private equity and beyond. Over a third of professionally managed alternative assets in Europe now incorporate ESG factors. Increasing numbers of impact-focused funds target measurable social or environmental benefits alongside financial returns.

Even newer alternative categories targeting “frontier” markets like the Middle East and Africa have developed to offer geographic diversification. Cryptocurrency-related funds also signify rising asset manager interest around blockchain technologies and digital assets. The ongoing innovation highlights the asset management industry’s drive to keep developing new alternative solutions for evolving investor priorities.

The Outlook Going Forward

Far from seeing demand peak, most industry forecasters only expect alternatives allocations to expand further. Preqin projects total alternative assets under management to reach $23 trillion globally by 2025, double current levels. New categories like private debt, real assets and custom solutions tailored to specific investor needs seem likely.

Of course, with success comes increased scrutiny. There is recognition that alternatives carry complexity, illiquidity, and frequently higher costs. Integrating them effectively within portfolios alongside traditional assets remains an art. Manager selection and due diligence also become even more critical given the bespoke nature of many alternative strategies.

Nonetheless, the long-term trends underpinning the growth and innovation seem robust. Alternatives offer tangible portfolio diversification and risk management benefits. In a multi-asset class portfolio, they play an integral role alongside stocks and bonds – complementing rather than displacing traditional assets. Far from fading, alternatives seem poised to only become more embedded into prudent asset allocation and portfolio construction approaches going forward. The diversification they provide offers investors the means to better manage risk and achieve investment outcomes aligned with their specific needs.

Final Words

The ongoing diversification into alternative asset strategies reflects a seismic shift in the investment landscape. What was once a niche, peripheral allocation has become a foundational component for investors of all types. Driven by the search for returns, diversification and innovative solutions, alternatives have transitioned from a novelty to a necessity in prudent portfolio construction.

Rather than a fleeting trend, the growth has been underpinned by long-term structural forces. Alternatives can enhance risk-adjusted returns while reducing volatility across market cycles. As investor priorities evolve, managers respond with bespoke vehicles and new categories to meet demand. While higher costs and complexity present challenges, the benefits outweigh the tradeoffs for most large institutional investors. Consequently, alternatives are poised to continue their exponential growth trajectory over the coming years. Innovative new strategies will proliferate as the industry thinks creatively. Alternatives are no longer an alternative – they have become core to achieving portfolio objectives. The diversification revolution has only just begun.