Issues for hedge fund COOs in 2013: Part 1
2013 was always going to be a busy year for hedge fund chief operating officers (COOs). A number of COOs we spoke to over the last six months have barely been able to hide their exhaustion, and indeed frustration, at the ever mounting regulatory requirements they are being forced to deal with. But what have been the biggest issues facing hedge funds during the last few months?
Performance for the year has so far been muted and unimpressive. June marked the end of six months of positive performance for most hedge funds, although the average manager is still posting gains albeit unsubstantial ones of 3.5%. Relative value arbitrage, event-driven and long/short equity hedge funds have been the top performers so far, and this success has translated into inflows for those strategies with the exception of long/short equity. Macro managers, despite suffering continuing underperformance, still managed to attract capital. Funds of funds have recovered following five years of dreadful returns, although this has not stemmed outflows. Commodity funds, having benefited from a long period of rising commodity prices, have so far posted losses of 3.5%. It is not surprising therefore 32% of investors told a Credit Suisse survey they planned to lower their exposures to these vehicles. Data from Hedge Fund Research indicates hedge funds control roughly $2.41 trillion in Assets under Management (AuM), a new high, while the total number of hedge funds exceeded 10,000 for the first time since 2006.
The travails facing SAC Capital, the $14 billion hedge fund founded by Steve Cohen, has shaken some in the industry. The hedge fund, which has one of the most impressive track records on Wall Street, was indicted by the FBI and US Attorney’s office in Manhattan on charges of insider trading, while the Securities and Exchange Commission (SEC) has accused Cohen of failing to properly supervise his employees. The allegations have prompted redemptions and widespread speculation the hedge fund will convert into a family office, assuming of course senior personnel are not banned from the securities industry. Prime brokers dealing with SAC Capital were reportedly questioning whether to terminate their relationships with the firm although the authorities’ decision not to freeze the hedge funds’ assets has provided some reassurance to those concerned counterparties. The events have prompted tougher questions of managers about their internal compliance programmes and policies from operational due diligence teams, while COOs fret the SEC and government investigators might become even more aggressive if the case against SAC Capital is successful. Another under-reported example of the SEC’s uncompromising approach was demonstrated by its rejection of the $18 million settlement offered by Philip Falcone, founder of Harbinger, following accusations he improperly borrowed money from his fund to pay a tax bill.
The deadline for the Alternative Investment Fund Managers Directive (AIFMD) came and went. One vocal expert on AIFMD described July 22 as one of the quietest days he’d had in the office in recent times. The full ramifications of AIFMD are unlikely to be felt by most UK managers until this time next year courtesy of the Financial Conduct Authority’s one year transitional period, enabling affected managers to meet their compliance obligations on July 22, 2014. Other national regulators are taking similar steps, although some, according to an AIMA and Ernst & Young paper, have made alarmingly little progress on transposing the directive into national law. Challenges do remain. Global custodians and prime brokers have yet to reach consensus on depositary liability. A number of global custodians are weary about accepting liability for assets held at the prime broker, with many demanding prime brokers fully segregate those assets so they can be reached in the event of a default. Failure to reach an agreement soon is likely to prompt an intervention from the European Securities and Markets Authority (ESMA). The rules on remuneration whereby hedge funds are likely to be forced to defer between 40% and 60% of their variable remuneration over three to five years, while a substantial portion of their pay package must be disbursed in shares or other related financial instruments, is still up in the air. The FCA has promised a proportional approach although ESMA is likely to revisit the rules on remuneration in 2015. Optimists point out an AIFMD brand, not too dissimilar to Ucits, could emerge, with 54% of managers telling a BNY Mellon survey they expected to see an increase in the amount of capital invested in alternative funds courtesy of AIFMD. Respondents cited the ability to distribute their product more widely as being the key driver for this growth. A number of managers are also behind the curve on their AIFMD reporting obligations, with 85% of hedge funds still unprepared for these requirements. However, most non-EU managers are adopting a “wait and see” approach to taking advantage of the private placement regimes on offer in EU member states, as ambiguities still exist.