Hybrid Alternative Investment Funds: Considerations, Challenges & Opportunities
Dublin / New York, October 20, 2022
Historically, alternative investment fund structures largely fell into one of two categories: open ended hedge funds and closed ended private equity funds. In the last few years, a hybrid model, taking elements of both these structures with the goals of portfolio diversification and reducing risk, has been developed. It combines the longer-term features of private equity funds with the flexible trading and hedging strategies associated with hedge funds. Correspondingly, fund managers and their service providers have evolved their infrastructure to be able to service these hybrid structures.
This article looks at the rise of hybrid alternative asset funds and looks at the challenges and opportunities associated with this type of structure.
Characteristics Of Hybrid Funds
Although they are often classified as direct private equity or hedge funds (hence are difficult to track), all hybrid funds have similar characteristics:
- Diversity: Hybrid funds allow managers to build a diverse portfolio. The fund manager can invest in multiple asset classes through the one fund structure.
- Liquidity: Hybrid funds seek to bridge the liquidity gap between traditional hedge funds and private equity by combining key elements of both disciplines. Their open or partially open fund structures ensure investors can withdraw or add capital at specified intervals, which is prohibited in a typical closed-end fund structure.
- Balanced Portfolio: Hybrid funds are more diverse in their investment strategy. They can make the best of both Private Equity and Hedge Fund asset classes, generating higher returns while diversifying risk. They can offer income generation in the short term and wealth creation in the long term.
- Flexibility: Hybrid funds satisfy investor demand by offering flexible structuring along with a broader reach, while investors can enjoy higher returns with more stability over time.
- Medium Term Investments: Hybrid funds are suited for medium-term time investments, usually around 5 years. Funds are often structured so that returns increase and more stable over a longer investment period.
Advantages Of Hybrid Funds
- Flexibility: Investors can have access to both hedge fund and private equity classes in a single product enabling them to avoid rigid structuring rules that focussed, single strategy funds display.
- Managed Risk: Risk can be managed through portfolio diversification, not only across asset classes but also across sub-classes within the asset class.
- Open structures: Their open or partially open fund structures provide for increased liquidity and ensure that investors have the opportunity to enter and exit at regular intervals.
- Yield: Hybrid funds allow investors to strike the right balance between risk and return by providing exposure to the predictable liquidity of hedge funds with the potential for earning the higher yields associated with private equity.
- Cost efficient: Launching a single fund rather than a series of funds brings cost and labour efficiencies to the fund manager.
Challenges Associated with Hybrid Funds
- Expertise: Managing hybrid funds involves additional complexity and requires more expertise than traditional funds. For example, fund set up, accounting, investor services and reporting requires expertise in both closed and open-ended funds. A competent fund administrator is a critical component to the success of hybrid funds. Rather than supplying a suite of individual products, administrators such as Centaur act as a single source, delivering overall administration solutions designed for each client, covering both hedge funds and private equity funds.
- Infrastructure : Administrators need to be able to deal with both private equity issues, such as capital calls and IRR calculations, and hedge fund issues, such as processing trades, valuing assets on a mark-to-mark basis. Unlike Centaur, many administrators focus on either private equity or hedge funds and struggle to combine the two disciplines.
- Regulation: The implementation of regulation, such as AIFMD and FATCA, has added a level of complexity to multi-layered fund structures. This has seen costs rise for all regulated firms as more capital is invested to meet regulators' demands. It makes economic sense for managers to outsource regulatory compliance functions to expert providers where possible. Administrators have been stepping into this role in recent years. They have the necessary skills and data to ensure that all funds comply with regulatory requirements. The same applies for complex structures, where the hybrid model reduces operational errors, delays, inaccuracies and risk associated with multiple fund structures.
- Technology: Traditional private equity fund administrators tend to lack the technology to manage hybrid funds. They rely on basic systems which have been developed to cope with private investments and which simply cannot cope with the new realities of institutional clients’ business. Good administrators have a combination of both private equity fund and hedge fund technologies supporting multiple investment strategies.
- Reporting: Managers want high quality, accessible and customized reporting from a single source and in a form that meets the managers, the investors and the regulator’s requirements. Successful administrators need to able to create robust and accurate reporting in a single report drawn from multiple sources. For example, Centaur’s reporting solution can generate data from hedge funds, private equity funds and Hybrids all to be presented in a single report.
These challenges highlight the importance of choosing a fund administrator that has the knowledge and expertise to service these products, using processes and technology which combine features of hedge funds and private equity funds. Rather than supplying a suite of individual products, Centaur acts as a single source, delivering administration solutions designed for each client, covering both hedge funds and private equity funds.
To find out more about Centaur’s Hybrid fund solution, please contact: