Static allocations may foil the growth ambitions of hedge funds

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  • Growth the top strategic priority for 67% of hedge funds this year
  • Battle to maintain margins, as costs outpace revenues for one in three managers
  • Polarity between large and small managers increases

Tuesday 10 December 2013 - As the hedge fund industry matures, managers who survived the financial crisis are beginning to focus on growing beyond their original business models, according to EY’s seventh annual survey of the global hedge fund market, Exploring pathways to growth. However the survey shows that, while managers want to grow their assets under management through new products and distribution channels, investors do not necessarily plan to increase allocations to hedge funds and are not interested in buying multiple products from one manager.

The 2013 global survey compares opinions from 100 hedge fund managers who collectively manage nearly US$850 billion and 65 institutional investors with over US$190 billion allocated to hedge funds. Topics covered in the survey include strategic priorities for hedge funds, changes in revenues and costs, technology, headcount, outsourcing and shadowing, and the future of the hedge fund industry.

Antoinette Elias, EY’s Oceania Asset Management leader, said: “In the current environment, fund managers are investing heavily to promote growth with 67% of managers globally saying growth is their top strategic priority this year.”

“Locally, Australian fund managers also have growth at the top of their agenda, with many of the larger players diversifying their strategies and product offerings.”

Managers more bullish about growth than investors

EY’s survey found managers globally were optimistic about their growth prospects. In addition to investing in new strategies and products, managers are developing distribution networks and channels in which they have traditionally not been engaged. However, it appears their optimism is not shared by investors.

A majority of investors (72%) say that they expect to maintain current allocation levels, while managers, particularly smaller managers, remain bullish about both inflows and market appreciation – managers with less than US$10 billion under management are budgeting for 15% growth in 2013.

“While managers seem determined to diversify their offerings, investors are much less interested in buying multiple products from the same manager. Instead, they seek the best type of manager for particular strategies. This explains why managers attract money from new clients at almost the same rate as they do from existing clients,” Elias said.

Battle to maintain margins, as cost increases outpace revenue growth

As investor and regulatory demands grow, managers are focusing relentlessly on operational efficiency and costs in the battle to maintain margins. According to the survey, two in three managers reported an increase in revenues over the past year as performance improved and assets grew. However, just half of managers reported improvements in margins. One in three managers said margins declined and another 10% noted margins remained unchanged as costs increased.  

Although three in four fund managers in Asia said that costs had increased, they have also been the most successful in raising capital and thereby growing revenue, and their margins have improved as a result.

Jon Pye, EY’s Oceania Hedge Fund leader, said: “Unlike their Asian counterparts, Australian managers have generally not seen the same growth in flows and for many conditions remain tough. While foreign capital remains an untapped source for many local fund managers, until the Investment Management Regime (IMR) is finalised, tapping that market remains a challenge.”

“While institutional investors are a growing source of direct funds for many global managers, local institutional investors – in the form of larger superannuation funds – remain highly fee sensitive. With the introduction of My Super, many would not even consider investment into a hedge fund with a traditional 2 and 20 structure, regardless of the net return. This approach may be short sighted though, as many of the best hedge fund managers outperform traditional managers on a net basis.”

Globally, managers attribute increased costs to developing infrastructure to meet demands of regulatory reporting, upgrading technology and scaling the business to service growing assets. Investors and managers are more aligned than in the past in their expectations for the future, with both groups expecting increased regulatory intrusions and accompanying costs.

“To date, despite the continued regulatory changes in the rest of the world, local hedge fund managers have been largely spared from undue regulatory burdens, having been deemed not to pose a systemic risk to the Australian financial system. However we are seeing some increasing disclosure requirements for some of the more complex funds pitched at retail investors,” Pye said.

Polarity between large and small managers increases

Increased polarisation in the industry is more evident than ever, with the largest funds succeeding because of their size and scale and their ability and willingness to invest in the business, and the smallest by virtue of simplicity. In particular, the largest and smallest managers have the most efficient headcount ratios between front-office and back-office personnel – the largest because they have been able to achieve economies of scale and the smallest because they cannot afford to be inefficient.

“Globally, fewer managers than in 2012 said they plan on adding headcount across front and back office functions – a sign that the pace of hiring is slowing,” said Elias. “However, the largest managers continue to add headcount at a faster rate than the overall market in virtually every function, including marketing, investment operations, risk management and legal/compliance, to ensure their operating models are adequate and scalable to support growth and meet the expectations of investors and consultants.”

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About the survey

Greenwich Associates, a global research and consulting firm, interviewed 100 hedge funds representing nearly US$850 billion in assets under management, and the views of 65 institutional investors representing over US$715 billion in assets under management, with over US$190 billion allocated to hedge funds. The objective of the study was to record the views and opinions of hedge funds and hedge fund investors globally, measure the views of each on the same topics and examine the two groups together. Hedge funds and investors were asked to comment on strategic priorities, changes in revenues and costs, technology, headcount, outsourcing and shadowing and the future of the hedge fund industry. For the full survey report, please visit www.ey.com/HedgeFundSurvey.

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Rebecca Aley
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