Hedge fund AuM to reach new peak, according to Credit Suisse survey
Hedge fund Assets under Management (AuM) will grow by 12% or $300 billion to reach an all-time high of $2.8 trillion, according to the sixth annual Credit Suisse investor survey.
These inflows come as the hedge fund industry recorded its best performance since 2009, with the average manager posting gains of 8.7% in 2013, according to data from the Chicago-based Hedge Fund Research. A number of prime brokers are predicting substantial inflows into hedge funds. Deutsche Bank Global Prime Finance’s Alternative Investment Survey is forecasting the global hedge fund industry could grow to $3 trillion by the end of 2014, up from $2.6 trillion in 2013.
“Hedge funds have done what they were meant to do and that is to protect investors against downside risk during turbulent market events. There has been a lot of criticism of hedge funds for trailing the S&P 500 during equity market rallies but these critics forget that during the financial crisis, when long only managers were down 40%, hedge funds were down just 20%. Institutional investors continue to move into hedge funds because they offer uncorrelated returns,” said Robert Leonard, global head of capital introductions at Credit Suisse.
Hedge funds have enjoyed significant inflows following the financial crisis spurred by the surge in institutional investors entering the alternatives space. A study by Barclays Prime Services said 60% of new flows into hedge funds in 2014 would be derived from institutional investors, of which 45% will come from public and private pension funds. “The majority of the inflows going into hedge funds are coming from the US,” added Leonard.
In terms of strategies, investors were most enthusiastic about event driven with a 19% increase in net demand, said the Credit Suisse survey. It added interest in long/short equity remained strong and global macro continued to appeal despite its substandard showing over the last few years. However, net demand for commodity trading advisors (CTAs) fell by 17% as trend following managers struggle to make sense of the uncertain macroeconomic terrain.
“Investors are reasonably bullish on macro strategies and they are projecting the strategy will deliver good returns in 2014. A lot of the money flowing into macro hedge funds will be re-allocations where investors are taking money out of the poor performers and investing into the more successful managers,” continued Leonard.
Investors are also expressing slightly more interest in regulated funds, according to the Credit Suisse survey. Twenty-six per-cent of investors in EMEA (Europe, Middle East, Africa) said they would increase their allocations in to UCITS vehicles, up from 21% in 2013. Interest in ’40 Act products is somewhat muted with 15% of investors intending to increase their allocations, up from 13% in 2012.
The lack of uptake in ’40 Act vehicles is surprising given how much attention they are presently receiving. A number of service providers are bullish on the future of liquid alternatives. Citi Prime Finance said it expected $939 billion of the $12.8 trillion in retail assets available to flow into liquid alternatives by 2017. Despite the perceived distribution benefits of ’40 Act hedge funds, they are costly to establish and are likely to be the preserve of only the largest managers. “Our survey polled institutional investors and not retail. Institutions are not as enthusiastic about regulated alternatives as retail investors which is why interest is more muted,” he said.
Investor appetite for start-up managers remained solid with 59% telling the Credit Suisse survey they can allocate to day one firms. However, this is not without terms and conditions. Forty per-cent of allocators said they were open to investing in a new fund with a founder’s share class. Just 11% said they would make a seed investment with economic interests and fewer than 6% said they would be a day one investor without any economic concessions.
Even established hedge funds are being forced to make concessions if they want to secure institutional investments. Thirty-nine per-cent of investors told Credit Suisse they preferred a management fee discount as a fee structure incentive as opposed to 12% who indicated a preference for a performance fee discount.
Hedge fund fees – the traditional 2% management fee and 20% performance fee - have faced downward pressure for several years now although the decline has been marginal. A survey of investors by the prime brokerage business at Goldman Sachs in 2013 found most hedge funds charged on average a 1.65% management fee and an 18.3% performance fee.
“Established hedge funds have by and large not reduced fees by a significant margin. In regards to start-up hedge funds, there is more pressure on fees from investors, particularly if that investor is an early stage allocator. Nonetheless, the barrier to entry for new managers because of regulations and the cost of operational infrastructure, means investors need to be sensitive on fees, and not force managers to make excessive concessions,” commented Leonard.
Investors also told the Credit Suisse survey they anticipated potential capacity constraints at hedge funds could emerge as managers return money, close to new capital or simply exit the business. Some firms are deliberately shutting out new investors amid concerns their funds are becoming too big to manage effectively, something which is likely to have a negative impact on performance.
A number of hedge funds including Egerton Capital and Citadel have been forced to stop accepting new capital in order to maintain their performance. The Credit Suisse survey added capacity constraints at these larger hedge funds could provide opportunities for newer and mid-sized funds to raise meaningful capital.
“There is a perfect storm of limited capacity due to funds closing to new capital and managers retiring or simply converting their businesses into family offices, while high barriers to entry continue to limit new supply. This does provide an opportunity for smaller managers as allocators such as pension funds and consultants, which would have historically invested in the bulge bracket firms, might start to put money to work at more mid-sized hedge funds,” said Leonard.
Regulation is no longer the main priority for investors dropping from a top two concern to fifth in the Credit Suisse survey. The survey said this was attributable to managers successfully incorporating many of the regulatory requirements into their business models.
“In 2013, many investors were unclear about what the regulations would look like. Policymakers were still even debating Dodd-Frank in 2013 while there was continued uncertainty about the Alternative Investment Fund Managers Directive (AIFMD). Today, investors have a better perception about what the regulation will look like and its implications on the hedge fund industry,” said Leonard.
US hedge funds have been filing their Forms PF and CPO-PQR with the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) respectively for around 18 months now. Despite initial complaints about the workload this regulatory reporting entailed, many hedge funds acknowledge the process has become more straightforward.
Nonetheless, European hedge funds are facing a torrent of reporting requirements courtesy of AIFMD, which forces firms to submit an Annex IV to regulators, not to mention reporting their over-the-counter and exchange traded derivatives transactions to trade repositories as mandated under the European Markets Infrastructure Regulation (EMIR).
“There is still a lack of clarity in the US about AIFMD, particularly in regards to what constitutes reverse solicitation. This is prompting some non-EU managers to adopt a ‘wait and see’ approach before marketing to Europe,” said Leonard.
Some optimists even believe AIFMD could turn out to be a marketing opportunity for managers. A number of European pension plans and insurers have been reluctant to invest in hedge funds because their mandates did not permit them to allocate into offshore vehicles. However, these conservative institutions might be more amenable to investing in AIFMs. “There is debate whether an AIFM brand could emerge that would rival UCITS. But at the moment it is too early to tell,” said Leonard.
In terms of top concerns among investors, respondents to the Credit Suisse survey cited crowded trades, risk complacency due to the low volatility environment and hedge funds chasing equity markets.
Credit Suisse surveyed more than 500 institutions with $1.16 trillion in hedge fund allocations.