Weathering the storm

There is a significant belief that the response forced by the market has been radical, rapid and productive for investors who are benefiting from greater transparency, improved governance and more clarity about valuations and valuation processes. Increased regulatory oversight on the other hand is perceived to be expensive, imprecise, and of less benefit to investors. This is not the consistent resistance of the regulated but the unemotional, matter-of-fact view of senior industry executives who are resigned to the fact that there will be significant regulatory oversight and are ready for it.

 

Fee structures have responded to investor pressure with clear linkages being established with liquidity and redemption terms. This is set to continue – few respondents felt that there was pressure to simply reduce fees, unlinked to structural changes. Interestingly the pressure has been largely on reducing management fees, rather than incentive fees. Respondents believe, perhaps naively, that limiting redemptions, imposing gates or suspensions and the like, will have limited impact in the long run.

 

Investors are now acutely focused on risk. Performance cannot be the panacea for the entire industry – even those who performed well through the crisis have suffered redemptions and been subject to far greater scrutiny on the risks they have been running. Sharing information about risk concentrations, leverage, governance and volatility is near universal and the frequency of demands has increased. In a post-Lehman era it is slightly surprising that counterparty risk has a fairly low ranking: less unsurprisingly, questions about bankruptcy laws in different jurisdictions and how customer protections operate features more highly.

 

There are likely to be very few funds that become tax refugees from the US.

Despite endless talk about the redomiciling of fund operations due to impending US tax legislation, few are seriously considering doing so. However, nearly a quarter of US and UK respondents say that management businesses, however organised, are considering moving because of tax and other burdens. People, unsurprisingly, remain more fleet-footed than the infrastructure they have set up.

 

The draft EU AIFM Directive will have a dramatic impact. Many of those affected, particularly in the US, remain uninformed about it. Approximately a sixth of respondents who had considered it said they would stop operating in the EU if it was passed in its current form: many more said they would not venture in. Although there is a general belief that it is unlikely that AIFM will be approved in its current form there is widespread concern as to its motivation and directional thrust coupled with a sense of disbelief that business legislation could be so politicized, under-consulted and restrictive.

 

Changes to the industry have been profound. Funds widely expect the industry to continue to consolidate with increasing costs and greater barriers to entry both playing a part in the process. Start-ups will be fewer and generally smaller than pre-crisis levels. Despite the obvious structural difficulties for M&A activity in the hedge fund space, the inexorable convergence in the wider asset management industry will take its toll as private equity firms, hedge fund managers and traditional long-only managers encroach on each others’ territory and distinctions become blurred. Fee structures, liquidity and redemption terms and investor demands for transparency and governance are likely to exacerbate the trend.

 

In conclusion, the industry has weathered the storm but is far from unscathed. Some changes have been profound and permanent, others perhaps more ephemeral. There remains more to come, not least from legislators, regulators and tax authorities. Although the industry appears resigned to accepting some such impositions 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.

 

Our full report can be read at www.ey.com