Investor-led changes – largely implemented and hugely beneficial, say hedge fund managers
Ernst & Young global hedge fund survey “Weathering the storm” Regulation is often blunt, misguided and expensive
ZURICH/NEW YORK, NOVEMBER 20, 2009 – The global downturn forced hedge fund managers to respond swiftly and radically to the demands of investors, finds a new survey published by Ernst & Young.
The survey was conducted by international research-based consulting firm Greenwich Associates for Ernst & Young and polled 100 of the world’s largest hedge funds. It highlights the significant changes to the governance, fund administration and investor reporting in funds over the last year, all of which have enhanced investor confidence without significant additional cost to the fund.
Respondents believe that increases in transparency and governance brought on by the crisis represent dramatic improvements for investors. They see this rapid transformation as proof that the industry can effectively respond to the needs of investors. This is in stark contrast to managers’ opinions about increased regulatory oversight, which they view as imprecise, of less utility to investors and overly expensive.
Cataldo Castagna, Head of Asset Management at Ernst & Young Switzerland, says: “The managers we interviewed are not opposed to new regulation. To the contrary, they understand that there will be stricter regulatory oversight and they are preparing for it. They are concerned, however, about alignment between regulatory bodies in the United States, European Union (EU) and elsewhere and the cost of compliance relative to any positive benefit to investors.”
Profound structural changes
The financial crisis has forced dramatic changes to the hedge fund industry with the managers interviewed changing liquidity terms (40%), investor reporting (38%), fund administration or custody (32%), fee structures (27%), and risk management (27%) since the beginning of the year.
Over half of the funds (56%) surveyed had made or planned to make changes to redemptions terms and/or fees. One in four has lowered fees because of investor pressure with nearly half having done such to entice new capital. More controversially, almost a third of managers opted to impose gates or suspensions on redemptions during the crisis but they remain optimistic that their actions will not have a negative impact on their ability to maintain or raise capital. Some 53% believed it would help maintain current investor capital in the fund over the long term.
Approximately 80% of managers responded that the primary area of focus for increased disclosure has been a better understanding of risk and performance. It is noteworthy that by a three to one margin investors are more focused on a better understanding of risk than performance. The most significant increases in risk management information shared related to risk concentration (95%) and leverage (71%). Nearly all respondents share this information on a monthly basis.
Jérôme Vial, financial expert at Ernst & Young’s Asset Management in Switzerland, comments: “All of these increased disclosures are seen by the industry as worthwhile initiatives, in which the benefits clearly outweigh the costs. However, almost half of the respondents indicated that some information is shared only with those who ask.”
Proposed EU Directive to have dramatic impact
Outside Europe, and particularly in the US, there is limited awareness of the draft European Commission Directive on Alternative Investment Fund Managers (AIFM). Approximately a sixth of respondents who had considered the directive said they would cease operating in the EU altogether if it was passed in its current form, with 30% saying they won’t set up an office there.
Over four-fifths of European funds believed that the Directive would increase costs, while 28% believed it would improve investor confidence; 26% thought it would slow down reporting.
“Although there is a general belief that it is unlikely that the draft directive will be approved in its current form, there is concern as to its motivation, its directional thrust and a sense of disbelief that business legislation could be so politicized, appear so misguided and be promulgated with such a lack of consultation,” says Jérôme Vial.
Future trends
Cataldo Castagna says: “We are observing a clear trend whereby hedge funds are assessing the set-up of a part or all of their business in Switzerland, in particular in the Geneva area.” The higher tax rate in London is clearly a driver of this trend but we should not forget that Switzerland offers a high quality of life, stable regulatory environment, and solid financial infrastructure. Jérôme Vial says: “We are also observing that the service providers to this industry are strengthening their presence in Switzerland to follow the trend of their clients. The current discussion around the AIFM Directive at European level, in particular regarding the relationships to non-EU countries and delegation of services to non-EU countries, will be interesting to follow and should definitely have an impact.”
Managers predict that the hedge fund industry will see consolidation as a result of recent events and expected regulation. Increasing costs and greater barriers to entry will mean fewer and smaller start-ups than prior to the crisis.
Cataldo Castagna concludes: “The industry has weathered the storm, but has not been left unscathed. Although it appears resigned to accepting legislation, regulation and tax changes, there remains a real fear of the authorities overreaching and some of the actions being fundamentally misguided, resulting in costs far outweighing any benefits to investors.”
About the survey
Greenwich Associates interviewed 100 hedge funds representing US$680 billion in assets under management (roughly half of industry assets) on behalf of Ernst & Young. The objective of the study was to better understand how market forces and the changing regulatory landscape are affecting hedge funds and what actions they are taking to prepare for a more uncertain future. Hedge fund managers were asked to comment on fees and liquidity/redemption terms, custody and prime brokerage, transparency/reporting to investors, US and EU regulation and tax legislation, regulatory reporting, independent valuation and their expectations for the future of the industry.
Download Survey (PDF, 640 KB)
Media Release (PDF, 47 KB)
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