Alternatives: Where Will Capital Come from in 2023?

Alternative asset fund managers are expecting to see a seismic shift over the next five years in terms of where they source their capital from, thereby forcing traditional lenders to up their game to entice sophisticated investors.

Banks and fund of funds managers are set to play less important roles going forward, while almost two-thirds of fund managers predict that Family Offices will become more prominent, according to Preqin’s ‘Alternatives: Where will capital come from in 2023?’ report, published this month.

‘Banking is all about regulation,’ Chris Beales, product manager and editor of the report, Future of Alternatives, at Preqin, told REFIRE. ‘The general feeling is that regulation is not going to become less stringent. That’s where Family Offices and other alternative lenders come in: they fill the void left by banks.’

Indeed, 41% of fund managers surveyed in the report expect banks to play a less important role in five years’ time, while 40% also expect fund of fund managers to play a diminished role. However, it is a different story for Family Offices, with 65% of managers predicting that they will become a more important source of capital by 2023.

Preqin is forecasting that the alternative asset sector globally will grow to $14trn of AUM by 2023, up from $8.8 trn today. And as borrowers become savvier, their interest in alternative sources of capital is rising, according to Curth-C. Flatow, founder and managing partner of Berlin-based advisory firm and alternative lender, FAP Group: ‘Potential borrowers are getting more used to alternative lenders; they’ve become more sophisticated,’ he told REFIRE. ‘This is partly because some deals have become more complex but also because the demand for information is much greater now.’

Next month (December), FAP Group will hold the first closing for its recently-launched FAP Real Estate Balance Financing 1 fund, a master-feeder fund, based in Luxembourg with a SICAV/SIF structure. The fund is expected to run for five years, with two one-year extension options. It will focus primarily on mezzanine loans on hotels, residential, offices and retail properties in Germany, Austria and the Netherlands, Flatow said. ‘We’re launching it in response to demand from German institutional investors for a fund like this,’ he said. ‘We will have the first closing in December and would like to grow the fund to €250m.’

Asian lenders to up their exposure to Europe

Asian capital, in particular, is expected to play a much larger role going forward, at a time when the share of capital coming from North America is expected to decline. Around 60% of fund managers surveyed by Preqin expect to source more capital from Asia-Pacific based investors, while 32% say that they expect to source less capital from North America over the next five years.

‘Asian capital is going to become more important as more investors become established in the region,’ said Beales. ‘Investors over there are looking to increase their exposure to alternative assets and that includes Family Offices. We expect more Family Offices to emerge in the future.’

Co-investments trumping pooled funds

Interestingly, by 2023, investors are expected to focus less on pooled funds in favour of co-investments, separate accounts and joint ventures, according to Preqin. Subsequently, 45% of fund managers anticipate less capital flowing to pooled funds, even though just 15% of investors share that view. ‘Pooled funds become less attractive as investors become more sophisticated,’ Beales said. ‘Many investors prefer co-investments and separate accounts because they have more of a say in what the capital is invested in.’

Subsequently, fund managers also expect to see more capital being invested through separate accounts and co-investments, at 39% and 42% respectively.

 ‘Although we’ve been talking of increased competition in alternatives for the past few years, it’s with good reason,’ said Beales. ‘With capital more often than not in the hands of a small number of investors, fund managers are looking to stand out from one another, enticing investors with more customizable fund structures. While pooled funds have in the past accounted for the majority of capital in alternatives, a significant proportion of fund managers expect this balance to shift. They predict a rise in co-investment activity, as well as more separate and managed accounts – structures that offer investors more control and often lower fees.’

New lenders to enter fray

As demand rises for additional junior capital, whether it be mezzanine financing or a stretched loan, ‘more lenders will enter the space’, said Flatow. ‘Other insurance companies will want to enter the market in Germany because Allianz has shown how sophisticated an insurer can be in structuring their debt business. New debt funds, both domestic and international, will also be launched. However, senior lending will stay in the hands of the banks, at least in Germany, which is pretty unique in Europe.’