Mid-sized hedge funds with USD100m to USD500m in assets are facing a reality gap, according to research released by RSM McGladrey, a professional services firm providing tax and consulting services.
While nearly 95 per cent of the hedge funds surveyed by Greenwich Associates believe they can meet institutional investors’ demands, only 22 per cent have more than one full-time employee responsible for client service, and only nine per cent have highly automated reporting systems.
"Attracting institutional assets will require new ongoing personnel expenses for the majority of mid-sized hedge funds, as well as significant up-front investments in technology to increase reporting capabilities," says Alan Alzfan, a managing director in the financial services group at RSM McGladrey. "Mid-sized hedge funds must understand that implementing best practices for a truly institutional platform is not an overnight process — it can take more than a year in many cases."
More than 90 per cent of the 52 US hedge funds surveyed have an unfocused business model, targeting all investors: institutional, fund of funds and high net worth individuals/family office.
Nearly one quarter of respondents (23 per cent) have seen an increase in institutional clients over the past two years, with 17 per cent reporting a decrease.
While there has been a net gain in institutional investment in mid-sized hedge funds, the diverging responses highlight the significance of having an institutional infrastructure: nearly half (47 per cent) of funds for whom institutional investors represent a majority of clients say having a dedicated client service team is "critically important" in winning assignments, with less than one-quarter (24 per cent) of funds with primarily HNW investors saying the same.
On average, funds with two or more full-time sales professionals won more than ten mandates in the past year; funds with fewer salespeople won seven.
Additionally, 37 per cent of mid-sized hedge funds report more burdensome reporting requirements regarding performance and risk. Almost 85 per cent believe that their current infrastructure is sufficiently scalable to handle client reporting needs for the next five years, yet 26 per cent report having either "manual" or "highly manual" reporting systems.
"Mid-sized funds represent a significant segment of the hedge fund market, and they are facing unprecedented pressures," says Alzfan. "These funds need to analyse the necessary steps for developing best practices at their organisations if they want to attract institutional assets."
Such steps include increasing staff to levels that are at least competitive with the current average of 1.5 to two full-time employees devoted to marketing among hedge funds that target institutional investors, and creating separation among internal functions to demonstrate that appropriate checks and controls are in place.
Nearly two thirds (64 per cent) of hedge fund managers state that institutional clients are "more burdensome" than HNW/family office clients, often providing questionnaires of 30 to 40 pages in length during the due diligence process and calling provided references.
There is also a new emphasis on liquidity, with one-third of funds planning to allow liquidity on a more frequent basis and reducing their lock-up periods as a means of attracting investors.
"Institutional clients tend to be more demanding about liquidity," says Alzfan. "But during the financial crisis, the funds with the loosest terms suffered the most redemptions."
Forty-one per cent of funds that experienced terminations over the past two years attributed clients’ decisions to liquidity needs.
"Some managers will choose to limit or even cease activity in the institutional space given the changes that are necessary to the funds’ business model to compete for institutional assets," says Alzfan. "But managers who want to gain consistent access to institutions’ large allocations of capital and the resulting fees – both management and incentive – will have little choice but to take on at least some of the risks involved in investing in their funds’ infrastructure and adjusting their liquidity terms."
