Although investment managers have relatively few assets in equity long and short investment portfolios, this segment of the market continues to grow rapidly as firms seek to diversify their business lines and compete with hedge funds, according to a report by Pershing and Finadium.
This new competition for assets has pushed some hedge funds into long-only investment strategies and others towards retail distribution.
The report suggests that investment managers will become more important to hedge funds as potential partners in product offerings and mergers and acquisitions.
Investment managers’ control of equity long and short investment portfolios is expected to rise from USD204bn to USD345bn by 2012, representing an increase from 19 per cent to 28 per cent of today’s USD694bn marketplace. According to a recent Finadium survey, 65 per cent of investment managers now operate some sort of long and short fund, up from 33 per cent one year ago. Independent hedge funds are also expected to continue to grow and increase their equity long and short portfolios to USD810bn by 2012 as equity markets recover.
Investment managers view potential regulatory reform as a wild card in driving convergence between themselves and hedge funds. The report indicates that some investment managers advocate working more closely with hedge funds as sub-advisors and potential acquisition targets with the expectation that increased regulation will occur. Without specific regulation, hedge funds will continue to have few legal obligations to disclose fees and practices.
Investment managers have notably different servicing needs than their hedge fund competitors. These organisational requirements have created challenges for investment managers looking to do business with noncustodian prime brokers, to the benefit of hedge funds with strong prime brokerage relationships. While investment managers are becoming more agile in their technology and operations, no party has surmounted the funding obstacles that regulatory and market pressures have put in place.
According to the report, hedge funds have a wide range of opportunities and challenges to take into consideration when evaluating the strategies of investment managers in the long and short arena. For example, hedge funds should consider tri-party custodial relationships which bring many traits of the asset management industry into their domain. These arrangements allow hedge funds to mitigate their counterparty risk by custodying cash and fully paid for securities with a less leveraged bank custodian, while prime brokerages still hold the fund’s short positions and provide margin financing.
Craig Messinger, managing director of Pershing Prime Services, says: "As investment managers increasingly expand into the equity long and short marketplace, hedge fund managers need to provide their investors with a distinct value proposition that uniquely positions them in the marketplace. Exploring new investment strategies, embracing potential merger and acquisition opportunities and offering clients innovative separately managed account solutions are several tactics hedge funds should consider to help continue growing their businesses."
Josh Galper, managing principal of Finadium, adds: "The growth of long and short mutual funds provides hedge fund managers with an exceptional opportunity to reach a new investor base with a relatively easy-to-understand, high-value offering. We expect long and short mutual funds to be an important asset gathering investment solution that will continue to help investors and fund managers achieve their financial objectives."
