Investor-Led Changes Were Hugely Beneficial, Say Hedge Fund Managers

by Phillip Morton, Investors Offshore.com

11 November 2009

A new survey published by Ernst & Young has concluded that the global downturn forced hedge fund managers to respond swiftly and radically to the demands of investors.

Significant changes to the governance, fund administration and investor reporting in funds over the last year have enhanced investor confidence without significant additional cost to the fund, according to the survey, 'Weathering the storm', which polled 100 of the world’s largest hedge funds.

The managers polled see the rapid improvements to transparency and governance as proof that the industry can effectively respond to the needs of investors. This is in stark contrast to managers’ opinions about increased regulatory oversight, which they view as imprecise, of less utility to investors and overly expensive.

Arthur Tully, co-leader of Ernst & Young’s Global Hedge Funds practice, says: “The managers we interviewed are not opposed to new regulation. To the contrary, they understand that there will be stricter regulatory oversight and they are preparing for it. They are concerned, however, about alignment between regulatory bodies in the United States, European Union (EU) and elsewhere and the cost of compliance relative to any positive benefit to investors.”

The changes this year to the hedge fund industry cited by the managers interviewed included:

• changing liquidity terms (40%),
• investor reporting (38%),
• fund administration or custody (32%),
• fee structures (27%), and
• risk management (27%).

Over half of the funds (56%) surveyed had made or planned to make changes to redemptions terms and/or fees. One in four had lowered fees because of investor pressure with nearly half having done such to entice new capital.

More controversially, almost a third of managers opted to impose gates or suspensions on redemptions during the crisis but they remain optimistic that their actions will not have a negative impact on their ability to maintain or raise capital. Some 53% believed it would help maintain current investor capital in the fund over the long term.

Approximately 80% of managers responded that the primary area of focus for increased disclosure has been a better understanding of risk and performance. It is noteworthy that by a three to one margin investors are more focused on a better understanding of risk than performance. The most significant increases in risk management information shared related to risk concentration (95%) and leverage (71%). Nearly all respondents share this information on a monthly basis.

Ratan Engineer, global leader of Ernst & Young’s Asset Management practice, comments: “All of these increased disclosures are seen by the industry as worthwhile initiatives, in which the benefits clearly outweigh the costs. However, almost half of the respondents indicated that some information is shared only with those who ask.”

Outside Europe, and particularly in the US, there is limited awareness of the draft European Commission Directive on Alternative Investment Fund Managers (AIFM). Approximately a sixth of respondents who had considered the directive said they would cease operating in the EU altogether if it was passed in its current form. 30% of those that invest on behalf of EU clients but without an EU office said they won’t set up an office there.

Over four-fifths of European funds believed that the Directive would increase costs, while 28% believed it would improve investor confidence; 26% thought it would slow down reporting.

“Although there is a general belief that it is unlikely that the draft directive will be approved in its current form, there is concern as to its motivation, its directional thrust and a sense of disbelief that business legislation could be so politicized, appear so misguided and be promulgated with such a lack of consultation,” says Engineer.

Despite endless talk about the re-domiciling of fund operations due to impending US tax legislation, the survey found that few funds are seriously considering doing so.

Managers predict that the hedge fund industry will see consolidation as a result of recent events and expected regulation. Increasing costs and greater barriers to entry will mean fewer and smaller start-ups than prior to the crisis.

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