Some hedge fund managers will have to use strategies like factor-based investing
Ian Barnard, partner at Capital Generation Partners, says that in order to cut fees hedge funds will stop taking third party money and become family offices.
Is Brexit a threat or an opportunity for hedge funds?
Some hedge fund managers we know have freely admitted that, despite supporting Brexit, it would damage their business.The issue for hedge funds and UK financial services, as well as for UK business in general, is what impact Brexit would have on their trade in Europe. For hedge funds, the passport authorisation is a boon to business on the continent. Whilst managers might bemoan Alternative Investment Fund Managers Directive (AIFMD), it is likely they will still have to conform to this EU standard. Another question is whether current or new EU rules would restrict access to European financial markets.
Tell us about hedge fund performance?
In a nutshell, there is too much money run by not sufficiently talented managers charging too high fees chasing too few opportunities. Hedge fund assets will continue to shrink until aggregate performance is sufficient to attract new investor capital. There is also a pro-cyclicality in allocation which means that the strategy that has done well in the past will have attracted the most capital, will most dominate the index and therefore have a large impact when its run ends. Weak Chinese growth and falling oil prices are return opportunities unless you are long China and oil. But there remain good managers charging sensible fees and making good returns. The challenge is to identify them.
What trends do you see in the hedge fund sector?
I think you will see a reduction in large institutional investors. Hedge funds were a big industry before the financial crisis and became even bigger afterwards. One of the factors was the arrival of large institutional investors intermediated by consultants. Some of those decisions were based on the outcome of optimisers using trailing returns. This is where performance figures roll over a longer period like a year. When you put more recent trailing returns which don’t have the longer spread into the same optimisers, you end up with much lower allocations to hedge funds.
What is the outlook for hedge funds on fees?
Asset withdrawals will continue until returns improve. One way managers can improve net returns is to cut fees or use lower cost strategies. These can include alternative beta which means managing volatile alternative investments or factor-based investing where the manager looks for underlying correlations in different asset classes. It means investors will no longer have to pay fees to get exposure to some types of hedge fund returns. So, we see a continuation of pressure on fees both the aggregate level and the basis on which they are charged. One consequence of this will be that some managers will stop taking third party money and become family offices.
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