Institutions May Change Hedge Fund Habits

by Carla Johnson, Investors Offshore, London

15 November 2002

Although hedge fund assets continue to power ahead - up by 10.6% globally to $600bn during the first nine months of this year, according to an industry report by Hedge Fund Research - a more important change taking place may be the growing institutional interest in alternative investments. Bloomberg surveyed industry executives recently and reported that industry executives believe fees charged by hedge fund of funds will probably go down as demand from institutional investors increases.

The problem for those investors who retain their freedom of action is to decide whether taking the King's shilling inevitably involves restrictions on investment behaviour (and hence on returns) or whether hedge funds will be able to have their cake (institutional distribution) and eat it (unregulated investment activity).

The relationship between the regulators and the funds themselves is a crucial part of the developing equation. Initially hedge funds registered with the SEC to target retail investors by offering lower investment minimums, but, says the Wall Street Journal, more and more hedge funds are registering in order to market themselves to pension funds and other institutional investors.

Currently, Employee Retirement Security Act rules restrict the amount of money unregistered funds can attract from retirement plans to 25% of total assets, whereas once registered, a hedge fund can accept an unlimited amount of money from these plans. Fewer than 100 hedge funds are currently registered with the SEC, and many of these come from large financial institutions that already have marketing networks for regulated funds. Increasingly, however, funds are filing special purpose registrations with lower fee structures, designed to appeal specifically to the institutions.

The Wall Street Journal says that K-2 Advisors, a Stamford, Conn., hedge fund adviser with $1 billion under management, is considering launching registered funds that invest in other, unregistered hedge funds. "We're always looking at structures that would be beneficial to our institutional client base, and registered funds are one of several areas we are exploring," said Elena Madariaga, general counsel for the firm.

It's still early days for the institutions' dance with the hedge fund sector, though. Total hedge fund assets still account for a mere 3% of invested savings, and reports suggest that so far, institutional investment accounts for just 1% of that, leaving the overwhelming bulk of institutional assets still to play for.

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