Market conditions continue to provide opportunities for certain hedge fund strategies and European investors look set to keep expanding their private asset programs, according to the latest Cerulli Edge―Global Edition.

Nearly two-fifths (39%) of asset owners in Europe that already allocate to hedge funds expect to increase their allocations over the coming 12 months. Of the private banks and wealth managers in the region, 36% are planning to increase their recommended allocations to hedge funds over the same period.

“Overall, the outlook for hedge funds in 2023 is more positive than it has been in recent years, thanks to rising interest rates and an uptick in volatility creating more opportunities. Sophisticated investors understand that now it is a good time to capture market dislocations and asset mispricing” says Justina Deveikyte, director, European institutional asset management research.

When it comes to private assets, Deveikyte notes that although there are still concerns that investors are overexposed due to the “denominator effect,” Cerulli’s research indicates that most investors remain well under-allocated so will continue to expand their private asset programs. “2022 proved to many investors that liquid alternatives can offer diversification and reduce risk,” she adds.

Many different investment vehicles provide exposure to private assets, but most product innovation is happening in the semi-liquid and European long-term investment fund space. Semi-liquid funds are becoming more popular among wealth managers and individual investors, especially high-net-worth (HNW) and ultra-HNW (UHNW) investors. Half of the UK wealth managers favor semi-liquid funds when investing in private markets. Demand for semi-liquid funds is also high in Italy and Switzerland.

According to the research, 39% of the 207 institutional investors Cerulli surveyed between December 2022 and January 2023 are considering increasing their allocations to liquid alternatives over the next 12 to 24 months, with particular focus on long/short equity, long/short credit, managed futures, and multistrategy products.

Of the 153 private banks and wealth managers Cerulli surveyed in January 2023, more than one-third (36%) plan to increase their recommended allocations to hedge funds and liquid alternatives. This response should, however, be seen against the existing relatively low base in Europe. Over the next two years, the most demand for hedge funds is expected to come from family offices and UHNW clients. Multistrategy, global macro, and equity market-neutral hedge fund strategies are likely to be favored. Relative value could experience a tough year: it was the only hedge fund strategy to see a net decrease (4%) in the number of private bank respondents planning to allocate to it.

The diversification liquid alternatives and hedge funds offer is among the factors motivating investors to look beyond traditional investments. Institutional investors are increasingly using non-UCITS and offshore hedge funds, with the focus on strategies that allow higher volatility and fewer environmental, social, and governance (ESG) restrictions in the hope of increased returns.

A benefit highlighted by the hedge fund managers is that any outperformance will appeal to investors that do not currently allocate to hedge fund strategies. Cerulli expects significant demand for infrastructure strategies from institutional investors as well as private banks and wealth managers.