Confidence in Hedge Funds Revives

by Glen Shapiro, LawAndTax-News.com, New York

20 October 2009

In late September 2009, market information provider Preqin surveyed more than 50 institutional hedge fund investors, including private and public sector pension funds, endowment plans, foundations and insurance companies, and compared the results with a similar survey in October 2008 – just as the global financial markets crashed.

In 2008, just under 40% of all surveyed investors were dissatisfied with their hedge fund investments following returns which had not met expectations – today this figure stands at around 27%. Of the investors surveyed in 2009, 62% stated that return expectations had been met, and a further 11% stated hedge fund returns had exceeded their expectations.

Preqin considered that the industry as a whole was successful in outperforming public markets following the crash, but a significant proportion of investors remained dissatisfied with their investments in hedge funds in 2008. In addition, the fact that hedge funds are a relatively liquid investment meant that investors that were satisfied and dissatisfied alike were seeking redemptions from existing investments in order to rebalance other distressed areas within their portfolios.

Preqin also mentioned that some investors with the more successful strategies had found themselves over-exposed to the asset class, and as a result made redemptions in order to rebalance. As a result, many hedge funds disappeared altogether and the industry shrank considerably, from USD1.93trillion at its peak to approximately USD1.3trillion today (source: Hedge Fund Research).

For 2009, returns were back in positive territory and some strategies had produced their best performances for five years or more, according to Preqin. This bounce back helped to restore some of the investor confidence that was lost in 2008, with 73% of investors stating that they were satisfied with hedge funds returns in 2009, up from 62% in 2008.

In addition, institutions invested once again in the asset class following their temporary suspension of activity at the end of 2008 and Preqin recently witnessed new investments being made by institutions such as Alaska Retirement Management Board and New Zealand Assets Management; 66% of institutional investors were either confident or very confident that their hedge fund investments met their investment objectives.

According to Preqin, if returns remained strong and managers learnt from the lessons of the crash, then investor confidence in the asset class should be restored to pre-2008 levels. As a result of this increased investor satisfaction, there was once again a net positive balance of investors planning to increase their allocation to the asset class: 29% of the investors surveyed planned to increase their investments, compared to only 20% planning to decrease them (and the balance of 51% planned to maintain their investment at current levels).

Among the institutions planning to reduce their investments in hedge funds, Preqin noted that in some cases this was due to short-term liquidity reasons. One European foundation told Preqin that it had cut some hedge funds from its portfolio unwillingly; because of their outperformance, hedge funds’ relative proportion of the total portfolio exceeded the maximum allowable by the board.

When asked what investors look for in hedge fund managers, Preqin was told that fund transparency had replaced fund performance as the greatest consideration. Risk management and firm reputation had also grown in importance to hedge fund investors following the high-profile hedge fund scandals which dogged the industry in the past 12 months.

Last year, according to Preqin, the performance record of a fund was of the highest importance, but now most investors choose hedge funds for portfolio diversification and to improve the risk/return profile of their portfolio rather than to produce outsized returns.

Just under half of all investors surveyed stated that they had not altered what they look for in hedge fund managers since the market crisis at the end of 2008. Of the investors which have altered their search criteria, 52% are now looking for increased liquidity, and a third look for more transparency at fund level. The Preqin survey stated that fees were a key issue for institutional investors, but they did not specifically set out to invest in funds that charged lower fees, preferring instead to negotiate fees with funds that exhibit characteristics which are more important to them, such as greater liquidity and transparency.

Preqin concluded that the hedge fund industry had changed, with fewer assets under management and fewer funds. Institutional investors were now the key source of capital to hedge fund managers – providing over 70% of the total assets in the industry. According to Preqin, managers needed to understand the needs and demands of these investors if they were to be successful in their search for institutional support.

To round up, Preqin stated that liquidity and transparency were key issues for the institutional investor. Funds that provide this would be very attractive to the institutional investor over the next 12 months. Also those hedge fund managers that were flexible in the terms and conditions associated with their funds would be more successful at gaining institutional support. The issue of fees was at the forefront of the hedge fund industry in 2009, and institutional investors were becoming increasingly dissatisfied with the traditional “2&20” structure.

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