Art Tully, co-leader of the global hedge funds practice at Ernst & Young, said: "The global hedge fund industry now manages US$2.5 trillion of assets; US$41.1 billion poured in from investors in the second quarter of 2007 alone. The industry appears to be proving that it can handle such inflows. The ability to absorb such flows is only tested by the capacity to grow and retain talent.
"Our survey demonstrates that managers are rethinking their infrastructure and operations to cope, not only to ensure scalability but, more importantly, to minimize any drag on performance. This is an evolutionary development for funds. To this extent we agree with industry commentators who say that funds are moving from institutionalization to 'industrialization', morphing into more typical asset manager-type structures."
New confidence
Thirty-seven percent of respondents are confident that their operations meet the needs of their investor base and don't see a need to change in the next two years. In addition, 21% say that they are likely to be able to offer products suitable for retail investors in the next two years, demonstrating a new confidence for the industry.
Only 13% of respondents expect to raise permanent capital in the next two years. The most popular route is deemed to be a partial sale to an external owner; and the greatest interest in raising permanent capital comes, perhaps surprisingly, from managers in the Far East.
David Sung of Ernst & Young's Hong Kong office said: "Given that the managers in the Far East have yet to experience the maturity of businesses in the US and Europe, the idea of having more permanent capital could be appealing as a faster means of stabilizing their asset base."
The challenge of greater transparency and managing operational risk
Greater transparency around the valuation process is the foremost medium- to-high level regulatory challenge for 64% of respondents in the next two years; conflicts of interest (57%) and market abuse (55%) are the next key concerns. Valuation and pricing risks were also deemed the second greatest operational risk for managers.
Mike Serota, co-leader of the global hedge funds practice at Ernst & Young, said: "Greater emphasis is being placed on a consistent approach to pricing and reporting of portfolios. While credit market dislocation may lead to short-term reactions and calls for greater transparency from the sector, there is a marked longer-term trend in awareness of the importance of comparable valuation approaches."
People issues were regarded as both a cause of, and the primary solution, to operational risk: 18% of respondents identified people as the main operational risk, but 34% said hiring the right people was key to mitigating that risk.
Three quarters of respondents identified technology as the biggest spending area in the next two years: for 58% of funds, expenditure on risk management systems was anticipated to be the biggest proportion of that spend.
Incentive and management fees set to fall
The survey shows that the majority of funds (80%) expect incentive fees and management fees to decrease in the next two years. Almost two-thirds also identified increased operational costs as a significant future pressure on fees over the same period.
According to Julian Young of Ernst & Young's UK hedge funds practice this is not as big a concern as it first appears: "Although pressures on fees may be downward, managers that consistently perform well - both on an absolute and relative basis - will also be able to continue to charge the fee structure they want. The poorer performers will be affected the most."
Two-thirds of respondents expect their investor lock-in period to decrease in the near future; just a fifth anticipate an increase.
Salary and culture attracting the best people
Hedge funds are working just as hard as other financial institutions to ensure they attract and retain the right people. Salary packages (86%) and firm culture (83%) are the main attractions enticing the best staff to join.
Art Tully concluded: "The real concerns for managers, across most of the regions interviewed, were with regards to retaining key personnel, such as portfolio managers, senior researchers and senior operations staff, including compliance and operational risk functions. Managers believe that compensation packages are clearly the most important means of winning the war for talent."
About the survey
- The survey was carried out in partnership with Ipsos MORI, an independent research company, across a number of leading global hedge funds, and fund of funds managers.
- Interviews were conducted with principals and senior operational executives, typically the chief operating officer and chief financial officer, to understand their concerns and focus. The thoughts of senior executives at over 100 of the top global hedge funds are here in this report. The questions we asked were designed to focus their minds on the drivers of change in the industry, in particular their impact on process, technology, strategy and people.
- The managers surveyed for this research represented some US$900 billion in funds (approximately 55% of the entire industry).
- The global coverage of respondents included 59% headquartered in the Americas; 26% in Europe; 14% in Asia Pacific and 1% other.
- The research was conducted between April and August 2007 via a 25 minute telephone interview with each interview split into 16 sections covering a broad range of industry topics.
