Hedge fund AuM to double by 2018, predicts Citi

Prime Brokerage
30 May, 2014

The global hedge fund industry is projected to double from $2.9 trillion to $5.8 trillion by 2018 while there is an increasingly blurred line between investors and hedge funds as the former start to build out their own asset management organisations to complement their portfolios, according to the latest Citi Investor Services survey.

The survey said institutions would account for 74% of those new hedge fund assets. Institutional investors, such as insurance companies and pension funds, are ramping up their exposures to hedge funds. A study by Deutsche Bank Markets Prime Finance in February 2014 found institutional investors now comprised two thirds of global hedge fund Assets under Management (AuM) compared to one third before the financial crisis. A similar report by Barclays Prime Services estimated 60% of new investor capital in 2014 would be derived from institutional investors, of which 45% would come from public and private pension funds.

This AuM growth would also be driven by the increasing retailisation of hedge funds, said the Citi survey. Demand for ’40 Act alternative mutual funds shows no sign of abating with the asset class attracting $95 billion of inflows in 2013 compared with the $67 billion which was invested into hedge funds last year. Citi forecasts AuM in ’40 Act alternative mutual funds will grow from $261 billion in 2013 to $879 billion by 2018. However, liquid alternatives are still in their infancy, and according to a Barclays study, comprise just 1%, or $137 billion of the $13.2 trillion presently controlled by the entire US mutual funds industry. Hedge funds themselves account for just one third of that $137 billion.

The distribution benefits of establishing an alternative mutual fund are enormous. Experts estimate there is approximately $19 trillion in assets up for grabs from defined contribution (DC) pension schemes, individual retirement accounts, annuity reserves, broker dealers and registered investment advisors (RIAs). However, 40’ Act hedge funds are subject to onerous restrictions. The absence of leverage (capped at 33% of gross assets), lack of performance fees (with a management fee of between 70 basis points (bps) and 1%), restrictions on investing in illiquid assets (capped at 15% of AuM), rigorous corporate governance standards and mandatory third party custody will all lead to higher compliance costs, at a time when profits are rapidly receding. These costs could also make it unsustainable for smaller hedge funds to launch regulated products.

The Citi study also said absolute return UCITS vehicles would see decent growth, predicting assets will increase from $310 billion to $624 billion by 2018. Nonetheless, some believe the UCITS brand is under threat.  A number of UCITS absolute return funds have underperformed and are facing regulatory scrutiny amid concerns managers, most notably Commodity Trading Advisors (CTAs), are shoehorning illiquid products into UCITS wrappers. Others predict institutional investor interest in UCITS will wane as firms increasingly launch funds compliant with the Alternative Investment Fund Managers Directive (AIFMD), which are subject to less onerous investment restrictions than UCITS. Some even reckon an AIFMD brand akin to UCITS could emerge although this is unlikely to materialise anytime soon.

The Citi study found many institutions investing in hedge funds had built out their own asset management organisations to complement their hedge fund portfolios. “In line with that move, these investors have also developed robust risk and portfolio management platforms that are allowing them to run factor analysis and trade overlay analysis on the position level information being fed to them by their set of hedge fund managers,” read the study. This trend is enabling some investors to co-invest into securities and markets alongside their hedge fund managers. These participants are also helping to fill a market-making and lending gap that has emerged as banks increasingly scale back their operations as concerns mount over their balance sheet strength.

The study added a number of investors were increasingly demanding “smart beta” from their managers.  It said a growing band of managers were now being given capital to run as long-only funds. Citi estimated long-only vehicles at hedge funds had approximately $183 billion in AuM.  A study in December 2013 by Deutsche Bank found nearly half of all hedge funds were running a non-traditional hedge fund product bringing them into direct competition with asset managers. Sixty-seven per cent of managers told Deutsche Bank that their rationale to launch long-only products was investor driven.

Citi surveyed industry participants with $1 trillion in hedge fund assets. 

CitiDeutsche BankBarclays40 Act FundsAIFMDUCITSlong-onlypension funds