Alternative Investment Management Association
By Ross Ellis, Vice President
Where are we today?
It has been nearly five years since the financial world was turned upside down. The events of 2008 and their aftermath are burned into the memories of asset managers and investors alike. For those who are still in the process of recouping their losses, the pain is all too present.
For the hedge fund industry, 2008 looms even larger as a watershed year. It’s not that clients exited en masse, or that hedge funds suddenly lost their touch. A year earlier, even though investors had long been disabused of the notion that hedge funds could be relied upon for positive returns every year, their role as portfolio diversifiers seemed secure. “Two and twenty” was the industry-standard fee, clients assumed their hedge fund investments would add value over time, and liquidity restrictions were accepted as part of the price for access to exceptional investment talent.
What a difference five years makes. After the financial crisis, any lingering feelings of complacency among investors dissolved. No longer is it assumed that a hedge fund will deliver unequivocal portfolio value, even if it can tout a good track record. And no longer can managers simply “show and tell.” Now investors want proof; they also want to “look under the hood” to funds’ inner workings and judge for themselves.
Key challenges and action steps
To explore what directions the industry is taking now, and how hedge fund firms can better equip themselves to succeed, SEI complemented this year’s global survey of institutional investors – our sixth annual – with wide-ranging roundtable discussions among top hedge fund practitioners in both New York City and London. Organized and moderated by Rachel Minard, CEO of Minard Capital, an outsourced marketing consulting firm, consultants and industry advisors were also represented, giving us a broad perspective on the future of the industry. On some topics, such as the need for hedge funds to provide proof of the value they deliver, we found strong consensus; on others, there was a sometimes surprising divergence of opinion — more evidence of the complexity and continuing evolution of today’s industry climate.
Entitled “6 Ways Hedge Funds Need to Adapt Now,” the study1 identifies key challenges hedge fund firms must meet if they hope to succeed in the long term:
When all is said and done, the hedge fund industry is here to stay. Exceptionally talented investment managers with original investment ideas will continue to seek the flexibility and opportunity that the hedge fund structure provides. Likewise, institutional investors will continue to want access to that top talent, and to differentiated alpha-generating strategies and return streams.
At the same time, the industry’s value proposition is being seriously questioned, and institutions continue to escalate their demands for transparency and intensify their due-diligence processes. There is no doubt that today’s climate of slower economic growth, low yields, elevated asset-class correlations and more competition makes it harder for hedge funds to live up to their past outperformance. It comes as no surprise that hedge fund managers increasingly object to studies and media reports that view the industry as monolithic, painting widely variegated strategies with the same broad brush of underperformance. Some see the institutionalization of hedge funds over the past 15 years as a double-edged trend that may hinder performance even as it brings more discipline and accountability to the industry.
The full report highlights many areas of potential change and improvement in hedge fund practices and client relationships but the overarching message that emerges is one centering on the need for better understanding among hedge fund management firms and institutional clients. Better-written mandates, more fully articulated investment processes, and added documentation may address symptoms of the industry’s current problems. Only through unhurried, unfettered and ongoing dialogue can true alignment of fund managers and investors — and truly successful relationships — be achieved.
 To request the full paper, visit www.seic.com/SixWays.
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