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 Matthew Nelson
Director, Market Intelligence
What a roller coaster ride it’s been for hedge funds. After 2008 many questioned the future of the hedge funds industry. Today hedge funds face the specter of pending regulation and unfriendly politicians eager to place blame on hedge fund managers. Even in light of these challenges, it seems that hedge funds are still the envy of Wall Street. Reports of enormous paydays for fund managers, outside investment from sell-side firms and increasing allocations from institutional investors are evidence that it’s still good to be a “hedgie.”
Certainly we can’t discount the uncertain regulatory future for hedge funds. Between registration, reporting transparency, protectionist regulation limiting cross-border investment and heavy tax burdens, it’s unclear exactly what will be required of hedge funds in the coming years.
That’s the bad news. However it appears that many hedge funds aren’t overly concerned with regulation. A recent survey by Greenwich Associates indicated that only 6% of the hedge funds surveyed saw pending regulation as a driver for making operational changes within their firm.
Now for the good news (for hedge funds). Many institutional investors are facing a funding crisis as their portfolios, still reeling from 2008’s losses are deeply underfunded and are desperately seeking alpha to help close the gap. Data from Mercer shows that pensions stood at 85% funded at the end of 2009. In a perfect storm environment for pensions as we have today; marked by low interest rates, moderate expectations for traditional asset classes and growing liabilities, the challenge is daunting. As a result, some have estimated that pension allocations to hedge funds could explode from the current average of 2.5% of assets to 15% over the next 10 years.
However, it’s headline news like the recent release of the top earning hedge fund managers that really rekindles the capitalistic fire that’s burned in many traders and portfolio managers at traditional shops for years. Stifled by poor performance in 2008, the news of Appaloosa’s estimated US$4 Billion earning in 2009 has certainly reinforced the belief that if you want to earn the big money, you have to be at a hedge fund.
But the times have changed for hedge fund managers. No longer will little more than a good idea and sparkling resume secure coveted institutional assets. The barriers for entry are higher now than ever before as investors, with recent industry scandals fresh in their minds, are lengthening due diligence periods and demanding far more information and insight into prospective hedge funds before they’ll invest. And since, according to Hennessee Group, institutional investors account for 75% of the assets in hedge funds today, they have tremendous leverage over all but the most prominent, marquee-name hedge fund managers.
Most hedge funds will need to demonstrate that theirs is a sound and trustworthy operation. Doing so will require many things of the manager, including proven, industry-standard technology partners and established, reputable service providers. Without these, managers will miss out on what could be a banner decade for the hedge fund industry.
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