ALFI: HNWIs returning to hedge funds although AIFMD causing distribution challenges

18 Mar, 2014

Appetite among high-net-worth-individuals (HNWIs) for hedge funds is growing, although the Alternative Investment Fund Managers Directive (AIFMD) is causing distribution challenges within the EU, it has been said.

“We are seeing a return of HNWIs into hedge funds, which is obviously a welcome development for the asset management industry,” said Gavin Rankin, head of managed investments for Europe, Middle East and Africa (EMEA) at Citi Private Bank in London, speaking at the Association of the Luxembourg Fund Industry (ALFI) spring conference in Luxembourg.

While HNWI interest in hedge funds may be on the rise, institutional investors continue to pile into the asset class. A survey on investor trends by Barclays Prime Services found that institutional investors comprised 60% or $1.5 trillion of the $2.5 trillion in hedge fund assets, with private investors (which also includes family offices) accounting for the remaining 40%.  

Wealthy individuals historically dominated the hedge fund investor base prior to the financial crisis. However, many suffered when their managers imposed gates and side-pockets, while others were unfortunate enough to have money invested in Bernard Madoff.

“Post-crisis, hedge funds are a totally different beast. There is a greater culture of compliance, more focus on liquidity and less leverage. They have become far more transparent and engaged with their investors too,” added Rankin.

Despite this positive development, fund distribution is under threat because of the soon-to-be-implemented AIFMD. AIFMs can continue to market to EU investors although they are subject to national private placement regimes, which vary substantially across member states. Some countries such as the UK are adopting a relatively liberal stance while others, namely Germany and France, are making it far more difficult to distribute alternative investment vehicles.

“We are very limited in terms of the hedge funds we can show our clients because of the AIFMD. Rather than easing fund distribution, AIFMD has made it harder. We face a patchwork of rules across the EU and there are some markets where we cannot distribute alternatives,” said Rankin.

However, AIFMD does present managers with potential marketing opportunities. A survey of fund managers in 2013 by BNY Mellon Alternative Investment Services (AIS) found 54% of respondents expected to see an increase in the amount of capital invested in alternative funds due to AIFMD. Fund managers cited their ability to distribute their products more widely, particularly to risk-averse investors such as pension funds and insurers, as being a key driver for this growth.

This could also lead to more managers creating onshore vehicles of their offshore equivalents. “The hedge fund industry will have to evolve because of AIFMD. If we want to gain more EU distribution, we might have to consider on-shoring some of our Cayman Islands and Delaware domiciled funds,” said Rankin.

Nonetheless, the majority of non-EU managers are adopting a “wait and see” approach towards AIFMD. A Deutsche Bank Markets Prime Finance survey of hedge funds with collective Assets under Management (AuM) of $325 billion found 61% doubted AIFMD would lead to new sources of investment while 39 % acknowledged they were unsure. Interest among US managers in particular remains muted with 90 % telling the Deutsche Bank study they were not enthused about AIFMD compliance even if the marketing passport was extended to non-EU funds.

The reasons for scepticism are many. The European investor base has been diminished and those that do remain are notoriously suspicious of the alternatives industry as a whole. This has been evidenced by the number of US managers undertaking cost benefit analysis so as to determine whether having a physical presence or marketing strategy in Europe makes economic sense.

Citi Private BankHNWIsBernard MadoffAIFMDBNY MellonDeutsche BankBarclays Prime Services