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All About Alpha

March, 2022

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Past performance is not necessarily indicative of future results. No assurance can be given that any investment will achieve its given objectives or avoid losses. Unless apparent from context, all statements herein represent GCM Grosvenor’s opinion.

 

Select risks include strategy risks, manager risks, market risks, and structural/operational risks. 

Current Outlook: A Rocky Year-to-Date

While 2021 brought us record economic growth, storm clouds were already beginning to brew by the end of the year. It was clear that record GDP growth rates risked slowing as stimulus money from the COVID-19 crisis began to dissipate. Fiscal policy was becoming difficult to sustain, suggesting it was reaching its limits, and monetary policy began tightening. In fact, the beginning of 2022 has been a perfect storm of decades-high inflation, rising interest rates, geopolitical instability-turned-war, not to mention the persistence of the COVID-19 pandemic. These factors combined to generate extreme market volatility that persisted through much of the first quarter. 

In our view, the combination and persistence of these factors means that investments reliant on beta are likely to continue to be very challenged. We therefore believe investors will need to seek alpha to drive returns and investing in alternatives can be a key source of such alpha. In the following, we highlight five areas within alternatives that we believe represent pockets of opportunity for alpha generation. 

We believe the middle market has a disproportionate share of investable opportunities compared to the large buyout market. Less than 30% of capital is allocated to buyout funds under $1.5 billion compared to the over 70% that is allocated to buyout funds over $1.5 billion. Historically, middle market buyouts also have a stronger performance track record than large buyouts, with net IRRs since 2000 between 13.5%-22.3% and 12.9%-18.7% respectively.
We believe the middle market has a disproportionate share of investable opportunities compared to the large buyout market. Less than 30% of capital is allocated to buyout funds under $1.5 billion compared to the over 70% that is allocated to buyout funds over $1.5 billion. Historically, middle market buyouts also have a stronger performance track record than large buyouts, with net IRRs since 2000 between 13.5%-22.3% and 12.9%-18.7% respectively.
Investments that are less exposed to transient market conditions and more exposed to secular trends can be a good source of alpha generation. Investors should prioritize opportunities where operational improvements and skill drive value as opposed to those that require financial engineering for return generation. Preference should be given to defensive businesses and those that benefit from long-term secular trends that will be resilient regardless of economic backdrop.
Investments that are less exposed to transient market conditions and more exposed to secular trends can be a good source of alpha generation. Investors should prioritize opportunities where operational improvements and skill drive value as opposed to those that require financial engineering for return generation. Preference should be given to defensive businesses and those that benefit from long-term secular trends that will be resilient regardless of economic backdrop.
Structural advantages can be created by utilizing different investment mechanisms such as negotiating lower fees for primary investments, capitalizing on structural alpha from co-investing to blend down overall fees, and sourcing, evaluating, and buying in the secondaries market at potential discounts to what we think are fair value.
Structural advantages can be created by utilizing different investment mechanisms such as negotiating lower fees for primary investments, capitalizing on structural alpha from co-investing to blend down overall fees, and sourcing, evaluating, and buying in the secondaries market at potential discounts to what we think are fair value.
A well-defined set of managers exist with a top tier track record; however, those managers are typically capacity constrained or closed to new investors. Relationships with elite managers can take years to build, but investors who have access are well positioned to see sustainable alpha generation potential. Allocators must also use their network of relationships to constantly mine for new pools of talent to ensure potential alpha sources do not become stale.
A well-defined set of managers exist with a top tier track record; however, those managers are typically capacity constrained or closed to new investors. Relationships with elite managers can take years to build, but investors who have access are well positioned to see sustainable alpha generation potential. Allocators must also use their network of relationships to constantly mine for new pools of talent to ensure potential alpha sources do not become stale.
Many investors are combatting low rates and historically tight spreads by taking more illiquidity risk. Instead, we believe investors should focus on sourcing from high quality sponsors. This allows one to be selective and focus on capital vacuums, investments with unique points of access, and pockets of dislocation. We believe sectors and spaces such as technology, where the market is still hesitant to lend and deals are being mispriced, have potential for alpha generation but deals must be underwritten properly to account for potential downside risk.
Many investors are combatting low rates and historically tight spreads by taking more illiquidity risk. Instead, we believe investors should focus on sourcing from high quality sponsors. This allows one to be selective and focus on capital vacuums, investments with unique points of access, and pockets of dislocation. We believe sectors and spaces such as technology, where the market is still hesitant to lend and deals are being mispriced, have potential for alpha generation but deals must be underwritten properly to account for potential downside risk.
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Conclusion

Current and potential forthcoming market conditions can be considered challenging but, in our view, opportunities still exist to generate returns. The importance of properly sourcing, structuring, and executing investments is going to be more important than ever before, as is overall portfolio construction and diversification. We believe investing in the broader markets is going to be highly challenging over the foreseebale future, and therefore investors should focus on alternatives where opportunities for alpha generation exist.

With approximately $72 billion in assets under management, GCM Grosvenor is one of the world’s largest and most diversified independent alternative asset management firms. We have the resources, experience, and long-standing relationships with elite managers to evaluate and implement investments flexibly across our open architecture platform.

Learn more about how we invest. 
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Important Disclosures

For illustrative and discussion purposes only. The information contained herein is based on information received from third parties. GCM Grosvenor has not independently verified third-party information and makes no representation or warranty as to its accuracy or completeness. The information and opinions expresses are as of the date set forth therein and may not be updated to reflect new information.
 

 
Investments in alternatives are speculative and involve substantial risk, including strategy risks, manager risks, market risks, and structural/operational risks, and may result in the possible loss of your entire investment. Past performance is not necessarily indicative of future results. The views expressed are for informational purposes only and are not intended to serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities by GCM Grosvenor. All expressions of opinion are subject to change without notice in reaction to shifting market, economic, or political conditions. The investment strategies mentioned are not personalized to your financial circumstances or investment objectives, and differences in account size, the timing of transactions and market conditions prevailing at the time of investment may lead to different results. Certain information included herein may have been provided parties not affiliated with GCM Grosvenor. GCM Grosvenor has not independently verified such information and makes no representation or warranty as to its accuracy or completeness.