Interest coverage and over-collateralisation tests are also important to maintaining robust risk management. A hedge fund is an aggressively managed portfolio of investments that uses leveraged, long, short and derivative positions. Once they acquire or control interest in a company, private equity funds look to improve the company through management changes, streamlining operations, or expansion, with the eventual goal of selling the company for a profit, either privately or through an initial public offering in a stock market. While both practice risk management by combining higher-risk investments with safer investments, the focus of hedge funds on achieving maximum short-term profits necessarily involves accepting a higher level of risk. Indeed, Hedgeweek reported that Dutch hedge fund allocator Theta Capital Management has just launched a dedicated vehicle in anticipation of a multi-year multi-faceted distressed credit cycle, as a result of the pandemic. This is because a private equity investment is less liquid and needs time for the company being invested in to turn around. As do their end investors. Hedge funds and private equity funds appeal to high-net-worth individuals. “The management and operational dynamics become different as you move across the illiquidity spectrum,” says Holt. In my work with McKinsey, I originated and optimized global strategic businesses in asset management and private equity. This is creating some convergence with specialist credit-focused hedge funds.”. As Headley points out, “there’s an ecosystem of data and operational support that is required to take advantage of opportunities in the marketplace today, in order to minimise operational risk.”. Hedge funds are alternative investments that use pooled money and a variety of tactics to earn returns for their investors. “We are seeing large specialist PE firms expanding their investment horizons on the debt side of the capital structure; whether that is distressed credit, syndicated loans, and structured credit. I think managers will look more broadly to deploy that capital to exploit opportunities so we might see more convergence in the credit space,” concludes Holt. This requires having specialised systems that can support investment operations across the trade lifecycle. Hedge funds may then lock those funds up for a period of months to a year, preventing investors from withdrawing their money until that time has elapsed. He continues: “On the risk management side, those moving into illiquid areas of the market face the challenge of knowing what their risk exposure is when the securities are not priced in the market. Hedge fund managers are increasingly offering vehicles outside their core funds with co-investment and longer duration private equity opportunities. Venture capital funds invest in early-stage companies and help get them off the ground through funding and guidance, aiming to exit at a profit. All Rights Reserved, This is a BETA experience. The aforementioned is with the overall backdrop that Alternatives as a whole made 25 percent of investors’ portfolios, up slightly from 2018. Liquid alternatives are a class of mutual funds that use alternative investing strategies similar to hedge funds but with daily liquidity. Indeed, according to the EY report, more than 25 percent of hedge funds have either a private equity or venture capital fund, while many private equity managers also offer liquid hedge fund strategies. Hedge funds tend to use leverage, or borrowed money, to increase their returns. This convergence theme is emerging as alternative asset managers seek to diversify and scale their businesses. Private equity funds invest directly in companies, by either purchasing private firms or buying a controlling interest in publicly traded companies. Private credit vehicles raised USD57 billion in the first half of 2020 according to research firm Preqin and with yield opportunities in structured credit and CLOs, as well as distressed credit, coming to the fore, the worlds of hedge fund and private equity investing are likely to converge. Moreover, as hedge funds and private equity funds seek out ways to extend their asset class coverage in credit markets, they need to consider operational risk issues when dealing with securities that have more settlement risk. 4. One example of how the two worlds of hedge fund and private equity investing are converging is CAVU Investment Partners, which was established when TowerBrook Capital Partners joined forces with New York-based LibreMax Capital, a structured credit specialist asset manager. Instead of charging an expense ratio only, hedge funds charge both an expense ratio and a performance fee. With the ripple effect of Covid-19 still being felt in the global economy, investment opportunities in high yield credit, and in particular distressed credit, have been numerous as investors seek out higher yield, at a commensurate higher risk. And … We are going to see even more large bespoke structures to meet a specific investor’s risk, liquidity and capacity assess needs, as again demonstrated a few weeks ago when Britt Harris recommended $1 Billion allocations to both BlackRock and JP Morgan for UTIMCO’s first strategic partnerships.