Hedge Funds Are Gradually Recovering From Crisis

by: AllAboutAlpha

Out of the woods, but still a bit dazed and confused and more than a little circumspect: That’s the message from Ernst & Young’s annual survey of senior executives at 100 of the largest global hedge funds, an update of which was released earlier this month.

Having already been profoundly affected by the financial crisis, hedge fund leaders see further changes on the horizon, according to the annual survey (click here to download the original full report released last fall, or click here to watch a video synopsis), which was compiled from responses gleaned from managers that collectively oversee some US$680 billion in equity long/short, multi-strategy and fixed income strategies, roughly half the industry.

Implicit in the key takeaways are some of the now-obvious: a greater focus on risk management, heightened efforts to both obtain and provide transparency, and more stringent due diligence all around. Less obvious, however, are managers’ and investors’ perceptions of fees and the long-standing battle over whether the standard “2 and 20” can and even should be applied.

As the charts below from the survey illustrate, it is the investors who are winning the battle, at least on the management-fee side of the coin. A whopping 87% of the managers surveyed are doing something to amend their management fees to entice or keep capital in their funds. Some 43% are lengthening lock-up provisions in lieu of lowering fees, while 26% are looking to lower their incentive fees as well. In total, 14% have done some combination of the above to get capital back in the door.

Source: Ernst & Young

In terms of fees and redemptions, 56% said they have either already made changes or plan to make changes to their redemption terms and / or fees, while 29% have already made changes to both (see chart below).

Source: Ernst & Young

It’s a far cry from the heady days of pre-2008, when some hedge funds were charging – and getting away with – fees as high as 5 and 50, in some extreme cases. Indeed, the sheer number of managers who theoretically are not only willing to adjust their fee structure but also provide more transparency is surprisingly strong.

(Editor’s note: AIMA Canada hosted its annual Parliamentary-style debate earlier this month, with the focus being on whether hedge funds are worth the price. We will bring you more on the debate, including who won and why in the coming days, but the surprise was what both sides agreed upon: that hedge fund managers who produce alpha deserve to be compensated.)

Government oversight and confusion over what the regulatory landscape will look like in the short term also figured prominently among managers’ concerns, according to the updated survey, though surprisingly most managers feel they’re ready to meet whatever requirements are eventually put into play.

Among the biggest worries is the European Union’s Alternative Investment Fund Management (AIFM) Directive, and whether it will be passed in such as way that proves both costly and difficult for managers outside the EU to conduct business, and vice versa. Of lesser concern was regulatory oversight in the US, which according to the survey results most are already braced for.

Also of concern is risk – market risk, transparency risk, counterparty risk, all kinds of risk – in particular as the “panacea of performance” fades, and demand for increased disclosure ramps up, according to the survey (see chart below).

Source: Ernst & Young

All in all, most hedge funds are cautiously optimistic, but cognizant of “profound change” that has yet to hit the industry full swing. We look forward to E&Y’s 2010 survey and getting a gauge on what managers feel the landscape looks like from that point.