Global hedge funds 'industrializing' in evolutionary development

Maturity bringing new confidence, says Ernst & Young report

London, 17 October 2007 — The world’s leading hedge funds managers are more concerned about attracting and retaining talented people and managing growth than anything else, according to new research — "Navigating new complexities" — published today by Ernst & Young.

The poll of over 100 top global hedge funds (and fund of funds) managers, collectively managing some US$900 billion in assets, shows that retaining the right people (42%) and managing growth (39%) are the highest level challenges over the next year, compared to just 9% who anticipate investing or developing in new products. Respondents were principals, chief operating officers and chief financial officers at these funds.

Art Tully, co-leader of the global hedge funds practice at Ernst & Young, said: “The global hedge fund industry now manages US$2.5 trillion of assets; US$41.1 billion poured in from investors in the second quarter of 2007 alone. The industry appears to be proving that it can handle such inflows. The ability to absorb such flows is only tested by the capacity to grow and retain talent.

“Our survey demonstrates that managers are rethinking their infrastructure and operations to cope, not only to ensure scalability but, more importantly, to minimize any drag on performance. This is an evolutionary development for funds. To this extent we agree with industry commentators who say that funds are moving from institutionalization to ‘industrialization’, morphing into more typical asset manager-type structures.”

New confidence

Thirty-seven percent of respondents are confident that their operations meet the needs of their investor base and don’t see a need to change in the next two years. In addition, 21% say that they are likely to be able to offer products suitable for retail investors in the next two years, demonstrating a new confidence for the industry.

Only 13% of respondents expect to raise permanent capital in the next two years. The most popular route is deemed to be a partial sale to an external owner; and the greatest interest in raising permanent capital comes, perhaps surprisingly, from managers in the Far East.

David Sung of Ernst & Young’s Hong Kong office said: “Given that the managers in the Far East have yet to experience the maturity of businesses in the US and Europe, the idea of having more permanent capital could be appealing as a faster means of stabilizing their asset base.”

The challenge of greater transparency and managing operational risk

Greater transparency around the valuation process is the foremost medium-to-high level regulatory challenge for 64% of respondents in the next two years; conflicts of interest (57%) and market abuse (55%) are the next key concerns. Valuation and pricing risks were also deemed the second greatest operational risk for managers.

Mike Serota, co-leader of the global hedge funds practice at Ernst & Young, said: “Greater emphasis is being placed on a consistent approach to pricing and reporting of portfolios. While credit market dislocation may lead to short-term reactions and calls for greater transparency from the sector, there is a marked longer-term trend in awareness of the importance of comparable valuation approaches.”

People issues were regarded as both a cause of, and the primary solution, to operational risk: 18% of respondents identified people as the main operational risk, but 34% said hiring the right people was key to mitigating that risk.

Three quarters of respondents identified technology as the biggest spending area in the next two years: for 58% of funds, expenditure on risk management systems was anticipated to be the biggest proportion of that spend.

Salary and culture attracting the best people

Hedge funds are working just as hard as other financial institutions to ensure they attract and retain the right people. Salary packages (86%) and firm culture (83%) are the main attractions enticing the best staff to join.

Art Tully concluded: “The real concerns for managers, across most of the regions interviewed, were with regards to retaining key personnel, such as portfolio managers, senior researchers and senior operations staff, including compliance and operational risk functions. Managers believe that compensation packages are clearly the most important means of winning the war for talent.”

About the survey

• The survey was carried out in partnership with Ipsos MORI, an independent research company, across a number of leading global hedge funds, and fund of funds managers.
• Interviews were conducted with principals and senior operational executives, typically the chief operating officer and chief financial officer, to understand their concerns and focus. The thoughts of senior executives at over 100 of the top global hedge funds are here in this report. The questions we asked were designed to focus their minds on the drivers of change in the industry, in particular their impact on process, technology, strategy and people.
• The managers surveyed for this research represented some US$900 billion in funds (approximately 55% of the entire industry).
• The global coverage of respondents included 59% headquartered in the Americas; 26% in Europe; 14% in Asia Pacific and 1% other.
• The research was conducted between April and August 2007 via a 25 minute telephone interview with each interview split into 16 sections covering a broad range of industry topics.

About the Global Hedge Fund practice
Ernst &Young is one of the pre-eminent professional services firm serving the alternative asset management industry. We have teams around the world, including North America, the UK, Cayman, Bermuda, Ireland, continental Europe, Hong Kong and Australia, who are part of our global alternative asset management practice. We are able to offer clients a seamless service around the globe as they grow their businesses. We try to anticipate the fiscal, regulatory, transactional, accounting and investor demands that the industry faces, influence their direction where we are able, and give our clients relevant, proactive advice.

About Ernst & Young
Ernst & Young, a global leader in professional services, is committed to restoring the public's trust in professional services firms and in the quality of financial reporting. Its 114,000 people in 140 countries pursue the highest levels of integrity, quality, and professionalism in providing a range of sophisticated services centered on our core competencies of auditing, accounting, tax, and transactions. Further information about Ernst & Young and its approach to a variety of business issues can be found at www.ey.com/perspectives. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited does not provide services to clients.

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