Survey reveals big changes in fund governance and administration
The global downturn has forced hedge fund managers to respond swiftly and radically to the demands of investors, according to a survey published by Ernst & Young.
The survey, Weathering the storm, was conducted by Greenwich Associates and polled 100 of the world’s largest hedge funds.
It highlights the significant changes to the governance, fund administration and investor reporting in funds over the last year, all of which have enhanced investor confidence without significant additional cost to the fund.
Respondents believe that increases in transparency and governance brought on by the crisis represent dramatic improvements for investors. They see this rapid transformation 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 US, European Union and elsewhere and the cost of compliance relative to any positive benefit to investors.”
The financial crisis has forced dramatic changes to the hedge fund industry with the managers interviewed changing liquidity terms (40 per cent), investor reporting (38 per cent), fund administration or custody (32 per cent), fee structures (27 per cent), and risk management (27 per cent) since the beginning of the year.
Over half of the funds (56 per cent) surveyed had made or planned to make changes to redemptions terms and/or fees. One in four has 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 per cent believed it would help maintain current investor capital in the fund over the long term.
Approximately 80 per cent 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 per cent) and leverage (71 per cent). Nearly all respondents share this information on a monthly basis.
Ratan Engineer, global leader of Ernst & Young’s Asset Management practice, says: “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. 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. Thirty per cent of those that invest on behalf of EU clients but without an EU office said they will not set up an office there.
Over four-fifths of European funds believed that the directive would increase costs, while 28 per cent believed it would improve investor confidence; 26 per cent 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.
Tully concludes: “The industry has weathered the storm, but has not been left unscathed. Although it appears resigned to accepting legislation, regulation and tax changes, there remains a real fear of the authorities overreaching and some of the actions being fundamentally misguided, resulting in costs far outweighing any benefits to investors.”
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