The hedge fund industry has grown in popularity over the past decade as investors, both the wealthy and the traditional retail consumer, sought above-average returns from this alternative investment vehicle. The growth by any measure has been substantial, and despite some recent setbacks during the global recession, assets under management are estimated to be $1.5 trillion, spread amongst a high of 12,000 firms across the globe in 2007, down to 8,400 firms today with an average portfolio size of nearly $180 million.
Although consolidation has reduced its ranks, the industry still looks forward to healthy growth prospects in the future, driven by strong performance in 2009 and broader access to the general public of investors. Net inflows have steadily increased, and sentiment is high for continued growth. The outlook for the balance of 2010 and beyond follows the major trends that are presently causing a significant shift in the hedge fund industry.
Consolidation
Hedge funds have been with us since 1949, but their popularity and population have grown dramatically over the past decade. By 1995, assets under management had grown to $250 billion. A few notable failures in the next few years threatened a potential mass exodus, but the turn of the century witnessed unprecedented growth as investors sought better returns for their investment dollar. The industry is concluding a period of consolidation in 2010 brought about by the downturn in global business activity.
|
Year |
Hedge Fund Firms |
|
2000 |
2,200 |
|
2005 |
10,000 |
|
2007 |
12,000 |
|
2008 |
10,000 |
|
2010 |
8,400 |
Despite the evident consolidation trend above, performance results in 2009 have created an industry launch pad of sorts for the years ahead. It is expected that the total number of firms will return to historical levels of healthy growth by the end 2010 as global markets stabilize and investors continue to search for the consistent, risk-adjusted performance returns that are the hallmark of hedge funds.
Transparency
Major pension funds around the globe are recognizing the advantages that hedge funds represent and are continually redesigning their selection criteria to allow for participation in alternative investment vehicles. However, the broadening institutional landscape does not come without a price. Reporting and disclosure requirements have necessitated more formal documentation of portfolio strategies, risk profiles and management techniques, and greater clarity on performance results on a daily basis. Those funds that respond with greater articulation of their investment strategies and management controls will continue to expand their market for new investment. Smaller funds under $1 billion in management will be more vulnerable unless they conform to new standards or close off old funds and begin anew going forward.
Regulatory Compliance
Financial reform legislation will predictably restrict the hedge fund industry on a global scale. Most managers believe strongly that regulation and governance will be the major challenges facing the alternative investment industry over the upcoming years. These changes will affect established as well as emerging players. However, if regulations are adopted in an uneven fashion across markets, then many funds may elect to move geographically in order to exploit potential loopholes. As a consequence, a talent brain drain will most likely occur as funds hire internationally rather than from a local market. Fund managers may have to learn forex to be effective.
The new Dodd-Frank legislation in the United States has shackled derivatives with a host of new compliance and reporting requirements, but it appears that new legislation will not end there. SEC Chairwoman, Mary Schapiro, has been critical of the industry in recent speeches. Speeches of this type are typically precursors of proposals to come, and it is widely known that officials believe that the “Flash Crash” in May was linked to unregulated hedge fund activities.
Talent and Compensation
The recovery of the industry has not included a return to the hiring levels from three years past. Hiring is expected to increase as the end of the year approaches, as the industry is still bonus-driven to a degree when it comes to attracting professionals. Aside from forex trading as noted above, the key talent objectives for hiring managers will include a proven regulatory compliance background and the ability to interpret and stay in front of regulatory challenges.
Compensation packages are also becoming more complicated due to regulatory compliance issues. “Clawback” and non-compete provisions will become standard, and more formalized contract structures will eliminate the “guaranteed bonus” approach that has prevailed in the industry. In general, these changes are designed to align the interests of the investment professionals with those of the investment community.
Concluding Remarks
Many experts are concerned that the recovery the industry is currently experiencing will be stymied as regulatory compliance continues to unfold across the globe. However, despite troubles in the last few years, the hedge fund industry continues to thrive as investors continue to want higher-than-average returns.
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