Alfred W. Jones opened the doors of the world’s first hedge fund firm almost 70 years ago. He could not have known it at the time, but his innovations would sow the seeds of a new industry that would change the face of investing.
The story of the hedge fund industry since then has been one of continued growth and innovation. Today’s hedge fund firms trade in everything from vintage wines to risk factors, using cutting-edge mathematics to manage risks and even to execute trades—the stuff of science fiction in Jones’s days.
At the same time, the industry’s investors have changed. The benefits of hedge funds are no longer restricted to the few. Pensions, university endowments, and sovereign wealth funds now number amongst the industry’s largest investors. The industry is also increasingly open to retail investors, meaning that everyday investors are able to access the same financial innovation and rigorous risk management that was once only available to the wealthiest investors.
Many have questioned what the future holds for the hedge fund industry, given its history of innovation. What kind of products will hedge fund firms offer to their new investor? How will they reconcile profits with social responsibility? Will hedge fund firms even exist in the future, or will they have been replaced by artificial intelligence systems? If they do still exist, and are still staffed with humans rather than machines, how will hedge firms navigate the coming generational change in leadership?
The Alternative Investment Management Association (AIMA) and Aberdeen Standard Investments (ASI) decided to answer those questions. We are delighted to introduce Perspectives: Industry Leaders on the Future of the Hedge Fund Industry, our look at the future of the hedge fund industry.
This paper is based on conversations with 25 of the leading figures in the hedge fund industry, from founding principals at hedge fund firms, to senior management at multi-asset managers, to industry academics. Collectively they represent close to 300 years of leadership experience in the hedge fund industry and over $500 billion in assets under management. We would like to thank them again for their participation in this paper, and for sharing their insights with us.
The picture those individuals painted in our conversations was of an industry embracing change while staying true to its primary focus of delivering for investors. They were excited about the challenges they faced and optimistic about their ability to evolve and remain valued partners to their clients. Far from failing to embrace change, hedge fund firms are thriving on it, exploring new ways of protecting and growing the capital of their investors.
This paper is also the result of the dedication of the members of AIMA’s Research Committee, who sifted through hundreds of pages of interview transcripts and spent months writing, editing, and rewriting dozens of drafts. We would like to take this opportunity to thank each of them for their efforts.
Chief Executive Officer, AIMA
Global Head of Client Driven & Multi-Manager Solutions, Aberdeen Standard Investments
By Tom Kehoe, Director, Global Head of Research, AIMA
The hedge fund industry is at an inflection point. Changing investor expectations are forcing hedge fund firms to rethink the investment solutions that they offer. The pace of technological change and the rise of artificial intelligence is leading some to question whether the hedge fund proposition will even exist in a few years. Responsible investment, meanwhile, is becoming more of a priority for hedge fund firms, as they gradually overcome their reluctance to constrain themselves. All of these changes are in turn forcing hedge fund firms to re-evaluate their own inner workings, from how they service investors through to how they build a business that outlasts its founders. For the purposes of this paper, the term ‘hedge fund firm’ includes diversified alternative investment management firms that provide investment management services including a variety of fund products, such as pure hedge funds and liquid alternative products.
The paper is based on the views of some of the leading figures in the hedge fund industry, including the leaders of asset management firms and renowned academics from around the world. Each participant shared their unique perspective on the changes facing the industry, and how best to contend with those changes.
Our conversations with the paper’s participants centred on three key questions:
- What must hedge funds do to maintain their value to investors?
- How will the hedge fund industry be shaped by external forces of disruption and global megatrends?
- How will the structure of hedge fund firms need to change in order for them to remain relevant to the investors and the workforce of the future?
In addressing each of these themes, this paper will examine the major issues facing the hedge fund industry. To begin with we will examine how the products offered by hedge fund firms are changing, and how this change is enabling the industry to cater to increasingly varied investor demands. Next, we will investigate the forces of change most likely to impact on the hedge fund industry over the coming decade: the rise of artificial intelligence and related technologies, and a growing demand for responsible investment options. The final part of this paper will explore how hedge fund firms are reacting to these transformations, changing everything from the services they offer investors to how they staff and structure themselves.
This paper is divided into three main chapters, which are in turn subdivided into two sections each. It is designed so that each chapter, and each section, can be read as a separate paper.
In recent years the hedge fund industry has been criticised over its performance (allegedly below par), its fees (allegedly too high), its size (allegedly too many fund management firms), and its next generation of leaders (allegedly too few in number). Put another way, hedge fund firms have been accused of not keeping up with a changing world.
What we found, however, was an industry embracing change. From the creation of new investment solutions to the implementation of cutting-edge technology to stay ahead of the pack, hedge fund firms are meeting the challenge. In the coming years, hedge fund firms will continue to refine not just what they deliver to their investors, but how they deliver it.
1. A paradigm shift
The hedge fund industry is experiencing a significant transformation. In the past customers tended to use unconstrained investors such as hedge funds to achieve alpha, while relying on traditional active and passive fund managers for beta. This industry model is now being replaced by a new range of investment solutions, each tailored to the needs of an increasingly diverse investor universe. Collectively, these new solutions constitute a paradigm shift in the hedge fund landscape.
Central to this shift are ‘smart beta’ and ‘alternative beta.’ These products have emerged from years of financial innovation, and offer investors access to the benefits of alternative investments—from diversification to the maximisation of returns—at a much lower cost than has historically been possible. Banks and mainstream fund managers are replicating these hedge fund techniques. However, thanks to their experience pioneering these solutions, hedge funds will be well placed to use them to meet investors’ risk and return goals.
2. Enduring alpha, enduring value
Despite what some critics have said, alpha is not becoming impossible to produce. Alpha has, and always will be, the rarest form of returns. Purely picking individual securities to gain an edge is increasingly difficult, given the wider availability of once-valuable financial information and the fact that markets are more efficient than in the past decades. Further, recent years have witnessed some investment strategies quickly delivering returns. Consequently, expectations of immediate success from other investment strategies have risen among investors; the majority of investment strategies must now work on compressed time horizons. Some of those strategies simply cannot realise optimum performance in such short timeframes.
Hedge fund firms can still deliver alpha through a combination of skill, knowledge, market timing, and judgement. They will need to compete harder to produce alpha, and evaluate ways of using different investment timeframes to maximise their advantage when doing so. Given the rarity of the skill needed to deliver alpha, investors will continue to pay a premium to those who can deliver it consistently.
3. Man and machine learning
Artificial intelligence and other cutting-edge quantitative techniques will soon become crucial to the hedge fund industry. Both systematic and discretionary hedge fund firms will need to use machine learning (a subset of artificial intelligence) in order to process information and make the best investment decisions possible. Artificial intelligence will be particularly important in short-term trading: firms operating in this area will likely need sophisticated artificial intelligence capabilities.
The complexity of financial markets data means that, for the foreseeable future, artificial intelligence will not be able to make accurate long-term financial predictions. As such, it will not usurp the integral role of humans in the investment world. However, hedge fund firms that do not develop artificial intelligence capabilities to aid their human employees may soon find themselves at a competitive disadvantage.
4. Investing, responsibly
Whilst good governance has always been important to investors, different forms of responsible investment are now increasingly becoming more widely adopted across the hedge fund industry. Today’s investors expect their investments to reflect their values and to account for long-term environmental risks; hedge fund firms are responding to investor demand.
While responsible investment can, in some cases, act as a constraint on a manager’s ability to generate profits, new technology is allowing hedge fund firms to implement responsible investment at a low cost. Some hedge fund firms are exploring whether the use of responsible investment can deliver outperformance. While not every hedge fund firm will adopt responsible investment in the near future, the confluence of investor demand, improving data, and technological capacity will likely push more managers to offer their investors a greater level of responsible investment opportunities.
5. The firm of the future
The shift towards systematic investing is pushing the hedge fund industry to hire new talent. Many hedge fund firms now hire highly quantitative talent—such as mathematicians, physicists, and computer scientists—instead of the traditional business school graduates. They are also moving beyond the industry’s traditional talent pools and hiring from a diverse range of identities and backgrounds. This is pushing hedge fund firms into direct competition with the technology industry for the brightest talent.
In order to get the most out of this talent, and to lure it away from the technology industry, hedge fund firms are changing how they work. In order to succeed in the future, hedge fund firms are encouraging internal collaboration and flattening their internal hierarchies.
Further, many hedge fund principals are now looking to institutionalise their firms and ensure a smooth handover to the next generation of leaders. As such, succession planning is becoming more common in the industry. Selling a portion of the management company ownership to external shareholders is one strategy being used by hedge fund firms to drive growth.
6. Partnering with investors
Hedge fund firms will focus on building closer relationships with their investors. As the hedge fund industry evolves and investor demographics become increasingly heterogeneous, multi-managers, with their resources, experience and infrastructure, are well placed to help investors access new opportunities tailored to their needs. There will also be greater development around co-investment options (in which a hedge fund manager invests in opportunities alongside its investors, working exclusively together on high conviction investment strategies), an even greater level of transparency, and true knowledge sharing as managers and investors align their interests more closely.
The hedge fund firms that are most likely to be successful will be those that prioritise how they are perceived by investors and the wider market. Central to such an outcome is the importance of trust, not only between hedge fund firms and their investors, but also between the industry as a whole and the wider public.
7. Sustainable success
Hedge fund firms are being forced to focus more on their business and distribution models, as they face increasing competition both from each other and from traditional asset managers. Hedge fund firms can no longer only focus on their investment products—they must think about how best to run their firms as institutionally-friendly asset management companies. As competition for capital flows intensifies, retail investors are likely to become an increasingly important source of growth for hedge fund firms. This is driving hedge fund firms to rethink their distribution models. Consequently, firms are exploring how to deploy best-in-class digital and mobile technologies to deliver the most cost-competitive solutions possible to their clients.
The hedge fund industry was born of disruption. Hedge fund firms have always been at the forefront of investment, embracing change and constantly innovating in order to deliver superior returns to their investors.
We live, however, in an era of profound disruption. Economic and social megatrends are reshaping societies and markets across the world, as old certainties fade and entire industries are imperilled. These changes are so profound that some have doubted the ability of even hedge fund firms to adapt quickly enough.
The hedge fund industry leaders with whom we spoke recognise the challenges they face. They know that they will have to embrace innovation in order to survive. They will need to harness artificial intelligence and respond to public opinion; reach out to new investors and offer new solutions to existing ones. They are confronted with phenomena that have toppled corporate titans and rent societies. Yet, they are optimistic.
Hedge fund firms have never had the luxury of standing still. The industry has had to justify its existence every step of the way, with investors constantly challenging them to match their highest expectations.
This has bred an industry conditioned to innovate. Hedge fund leaders have always kept an eye on the horizon—they cannot afford to be behind the curve on anything. We saw the results of this attitude first-hand when we spoke to those leaders. Never did they hesitate when answering our questions, or tell us they were not familiar with a subject we raised. They had already thought about how artificial intelligence would be integrated into their firms; they could explain how they would reach new investors in minute detail.
In doing so they answered a question that went unasked in our conversations: are hedge fund firms ready for the future?
The answer they gave was simple and unequivocal: ‘yes.’
Seth Fischer (Founder and CIO, Oasis Capital) on working in the hedge fund industry:
“There’s nothing better than this job. I love it. When I heard about hedge funds and looked at hedge funds 23 years ago I said, 'let me get this right: you have a pool of capital and you can just try to make money with that capital?' It’s all I wanted. When I was in college I was trying to buy things and sell things and now all of a sudden I have capital and I can scour the world for opportunity, and use that capital to pursue opportunities. Not only that, but I have a large amount of resources to analyse those opportunities and execute those opportunities. Every day is a new day, and every day you have to be learning. It's endlessly interesting, and I think it’s great. This is what I want to do.”
We are grateful for the contributions of the following participants in this paper:
- Lee S. Ainslie, Founder, Managing Partner and Chief Executive Officer, Maverick Capital
- J. Kyle Bass, Founder and Chief Investment Officer, Hayman Capital
- Dr Leda Braga, Founder, Chief Executive Officer, Systematica Investments
- Dr Jane Buchan, Managing Director and Chief Executive Officer, PAAMCO; Co-Chief Executive Officer, PAAMCO Prisma Holdings
- Dr Ray Carroll, Chief Investment Officer, Neuberger Berman Breton Hill
- Luke Ellis, Chief Executive Officer, Man Group
- Seth Fischer, Founder and Chief Investment Officer, Oasis Capital
- Fiona Frick, Chief Executive Officer, Unigestion
- David C. Haley, President, HBK Capital Management
- Dr Campbell Harvey, Professor of Finance, Fuqua School of Business, Duke University; Research Associate, National Bureau of Economic Research; Investment Strategy Advisor, Man Group
- J. Tomilson Hill, Chairman, Blackstone Alternative Asset Management; Vice Chairman, Blackstone
- Sir Michael Hintze, Founder, Chief Executive Officer and Senior Investment Officer, CQS
- Philippe Jordan, President, Capital Fund Management
- Anthony Kaiser, Founder, Chief Executive Officer and Chief Investment Officer, Kaiser Trading Group
- Omar Kodmani, Senior Executive Officer, EnTrustPermal
- Robert S. Koenigsberger, Founder, Chief Investment Officer, and Managing Partner, Gramercy Funds Management
- Dr Jim Liew, Assistant Professor of Finance, John Hopkins Carey Business School
- Sir Paul Marshall, Chairman and Chief Investment Officer, Marshall Wace
- Andrew McCaffery, Global Head of Client-Driven and Multi-Manager Solutions, Aberdeen Standard Investments
- Dr Robert C. Merton, School of Management Distinguished Professor of Finance, Massachusetts Institute of Technology
- Dr Lasse H. Pedersen, John A. Paulson Professor of Finance and Alternative Investments, New York University Stern School of Business; Professor of Finance, Copenhagen Business School; Principal, AQR Global Asset Allocation
- Stuart Roden, Chairman, Lansdowne Partners
- Paul Sabourin, Chairman, Chief Investment Officer, and Portfolio Manager, Polar Asset Management Partners
- Kenneth G. Tropin, Founder and Chairman, Graham Capital Management
- Danny Yong, Chief Investment Officer and Founding Partner, Dymon Asia Capital
- Carol Ward, Chief Operating Officer, Man GLG
- Max Budra, Research Associate, The Alternative Investment Management Association
- Ermanno Dal Pont, Managing Director, EMEA Head of Capital Solutions, Barclays
- Richard Hindley, Head of Marketing, ARG Asset Management
- Cédric Kohler, Head of Advisory, Fundana
- Dr Robert Kosowski, Associate Professor, Imperial College Business School; Head of Quantitative Research, Unigestion
- Dr Anthony Ledford, Chief Scientist, Man AHL
- Jennifer Mernagh, Investment Strategist, Aberdeen Standard Investments
- Hugh Orange, Chief Financial Officer and Chief Compliance Officer, Lansdowne Partners
- Michael Peltz, Global Head of Content, WorldQuant LLC
- Axel Pierron, Managing Director, Opimas
- Michael Weinberg, Chief Investment Officer, Protégé Partners
And the members of AIMA’s Research Committee