Private investor capital in hedge funds at pre-crisis levels, finds Goldman Sachs survey

Prime Brokerage
30 Apr, 2014

Private investor capital managed by hedge funds has returned to levels not seen since 2008, according to a survey of allocators conducted by the capital introductions arm of Goldman Sachs Prime Services.

Private capital – which comprises private banks, family offices, wealth managers and high net worth individuals (HNWIs) - now accounts for 22% of the $2.7 trillion in global assets controlled by hedge funds, up from 17% in 2012, said the Goldman Sachs survey. Conversely, institutional investors’ share of industry assets failed to grow for the first time since 2008. “After several challenging years post-2008, private capital is for the first time back to its pre-crisis levels,” read the survey. 

Private investors have been historic backers of hedge funds although poor performance during the financial crisis and the subsequent imposition of gates and side-pockets by managers facilitated an exodus. A number of private investors also found themselves exposed to frauds, of which Bernard Madoff was only the best known, although it appears some have regained confidence in hedge funds.

However, institutional investors remain dominant accounting for 46% of the hedge fund industry’s assets. The institutionalisation of the hedge fund industry is well-documented and is often making it an uphill struggle for smaller, sub $100 million managers to raise meaningful assets. The Goldman Sachs study found 50% of investors said they had minimum AuM (Assets under Management) requirements at hedge funds, which on average stood at $235 million.

Regulation and institutional investor demands that managers bolster their operational infrastructure has made it prohibitively expensive for some start-ups. A study by Citi Prime Finance in 2013 found hedge fund managers needed at least $300 million in AuM to enable their management fee to cover their operating costs and regulatory requirements.  That same survey undertaken by Citi Prime Finance in 2012 found managers running less than $250 million spent approximately 198 basis points of their 2% management fee on operations and third party service providers alone.

Despite widespread reports and comments by vocal investors about downward pressure on the traditional hedge fund fee model, little has changed. Goldman Sachs found the average management fee to be 1.6% and the average performance fee to be 18.1% in 2013, a marginal drop from 2012. A survey of clients by law firm Seward & Kissel reached a similar conclusion, finding management fees stuck around 1.6% while performance fees continue to be pegged at 20%.

The Goldman Sachs study also found investor allocations to newer managers (defined as those with less than three years track record) remained stable at 45% in 2014, a negligible decline from 46% in 2013. Nonetheless, the study said investors estimate their allocations to managers with less than $500 million in AuM would decrease from 42% in 2013 to 35% in 2014.

Funds of hedge funds continue to fold, added the survey. The troubled asset class comprises just 32% of investor respondents to the survey, a fall from 35% in 2013 and a far cry from their 2008 heyday when they accounted for 61% of respondents.  The gradual demise of funds of hedge funds comes amid substandard performance following the financial crisis, not to mention investor resentment at their added layer of fees. A growing number of funds of hedge funds are being forced to consolidate or shutter. In 2013, EIM was sold to Gottex Fund Management creating a $10 billion joint venture, while Carlyle Group bought the Toronto-based Diversified Global Asset Management, and Morgan Creek acquired Signet Group. Many of these firms have elected to merge in order to attain size and scale. The asset class as a whole continues to decline although recent figures from Eurekahedge, a data provider, indicated assets managed by funds of hedge funds shrunk at a slower rate in 2013 than previous years. This could be attributable to an improvement in performance with the average fund of hedge funds returning 7.47% for investors in 2013. However, some have said this turnaround has more to do with the equity market rally as opposed to a successful reinvention of the funds of hedge funds model.

Many funds of hedge funds are also struggling to compete with investment consultants, which charge far more competitive rates. The 2013 survey by Goldman Sachs found 65% of pension funds and 45% of insurance companies employed consultants to assist them with their hedge fund allocations. A Barclays Prime Finance study estimates investment consultants control approximately $830 billion in hedge fund assets, a 30% increase since 2010. Albourne Partners, with roughly $288 billion in Assets under Advisement (AuA) is by far the world’s most powerful hedge fund investor.

Investor return expectations are also increasing, found the Goldman Sachs survey. The average investor is targeting 9.5% from their hedge fund portfolios, a rise from 9.2% in 2013. Single family offices are the most aggressive performance chasers with return expectations of 11.4%, followed by sovereign wealth funds at 11.3%. These heightened return expectations come as hedge funds saw their best performance since 2009 last year posting gains of 8.7%, according to data from the Chicago-based Hedge Fund Research. However, returns have been more muted year-to-date 2014 with the average manager delivering just 1.11%, according to the latest Hedge Fund Research figures.  Despite this, investors told Goldman Sachs they expected global hedge fund AuM to grow by around 10% over the coming year.

In terms of strategy allocations, long/short equity is the most popular accounting for 28% of investors’ portfolios, according to Goldman Sachs. This is followed by roughly equal allocations to credit, multi-strategy, global macro and event driven managers.   In line with other industry surveys, investors told Goldman Sachs they would pull cash out of Commodity Trading Advisors (CTAs) and managed futures. These trend following strategies have struggled of late amid the unpredictable macroeconomic environment. A mid-year study by Credit Suisse’s prime brokerage group in 2013 found just 7% of allocators would increase their investments into CTAs, a downward swing of 30% from 2012. 

Regulated alternatives such as absolute return UCITS and 40 Act structures continue to generate interest, said the Goldman Sachs study. Thirty-five per-cent of all allocators invest into UCITS hedge funds. For European investors, this figure increases to 60% with UK and Spanish-based allocators comprising two thirds of European UCITS assets. UCITS absolute return vehicles account for just over €200 billion of the €6.69 trillion controlled by UCITS funds as a whole. A number of UCITS absolute return funds have, however, underperformed and faced regulatory scrutiny amid concerns managers, most notably CTAs, are shoehorning illiquid products into UCITS wrappers. Others predict institutional investor interest in UCITS will wane as firms increasingly launch funds compliant with AIFMD (Alternative Investment Fund Managers Directive), which are subject to less onerous investment restrictions than UCITS. Some even predict an AIFMD brand akin to UCITS could emerge although this is unlikely to materialise anytime soon.

Twenty-two per-cent of US investors and 16% of global investors put money to work in 40 Act structures. Unsurprisingly 91% of asset managed by ’40 Act hedge funds comes from private investors, added the Goldman Sachs study. The liquid alternatives industry is growing at a faster rate than traditional hedge funds as investor interest in these regulated structures shows no sign of abating, according to a study by Barclays Prime Services. The liquid alternatives space grew by 43% in 2013, while hedge funds saw their assets increase by 15% to reach $2.6 trillion in 2013, said the Barclays study. However, liquid alternatives are still in their infancy and 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 one third of that $137 billion. Some pessimists reckon ’40 Act hedge fund structures will tread a path similar to that of 130/30 funds, which faded into oblivion in the aftermath of the financial crisis.

Goldman Sachs surveyed 688 global investors with $1.3 trillion directly invested in hedge funds. 

Goldman SachsCiti Prime FinanceBarclaysUCITS40 ActCredit SuisseSeward & KisselHedge Fund ResearchEurekahedgeAlbourne PartnersAIFMD