Hedge fund managers must rethink their business models, provide tailored solutions, and offer multi-faceted client communications, according to a study conducted by SEI in collaboration with Minard Capital.
This amidst a climate in which investors are heavily scrutinising the industry's value proposition. SEI's insights are based on the company's sixth annual global survey of institutional investors, as well as insights from nearly 50 hedge fund managers, investors, and consultants who participated in roundtable discussions in New York and London organised and moderated by Minard Capital.
"With an increasingly crowded field of competitors, rising institutional demands, and a decade of disappointing overall returns, hedge funds are at a critical juncture," says Ross Ellis, vice president, knowledge partnership for SEI's investment manager services division. "Based on what we heard from institutional investors and fund managers, it's time for the industry to make an evolutionary leap in proving its worth to a hungry yet hesitant investor base."
"Success in identifying, securing, and retaining institutional and private client assets today requires new tactics. These include a defensibly true and transparent investment process and a competitive edge that is verifiable internally and corroborated by the investor," says Rachel SL Minard, founder and chief executive of Minard Capital. "Managers must know how to defend their edge against competitors, investment instruments, and vehicles investors now have at their disposal to meet their risk/return targets."
The study, "6 Ways Hedge Funds Need to Adapt Now," identifies key challenges hedge fund firms must meet if they hope to succeed in the long term:
• Sustainable edge. With seven in 10 survey respondents asserting that "there are too many look-alike strategies in the industry," institutional investors are raising the bar for manager selection. To be competitive, hedge fund firms should focus on articulating a differentiated investment approach, a clear process, and proof that their edge can be sustainable.
• Adaptability. Roundtable participants noted that the combination of converging investment structures, shifting investor demands, and challenging market conditions are causing hedge fund managers to rethink their business models and develop multi-faceted solutions that package their capabilities most effectively.
• Clear value added. Investors are increasingly concerned with how much "true alpha" they are getting for the hedge fund fees they pay. While most of the institutions surveyed are still planning to maintain or modestly increase hedge fund allocations, only 38 per cent reported being satisfied with risk-adjusted hedge fund returns, down from 62 per cent a year ago. Moreover, six in 10 of the institutions surveyed believe it is possible to meet investment objectives without allocating to hedge funds.
• The right fit. Today's investors have complex needs and want hedge funds to serve multiple objectives within an overall portfolio mix. Poll results suggest that rather than "pitching products," fund managers should use an interactive, problem-solving approach to match their capabilities to investors' specific objectives. It also calls on institutional investors and consultants to develop clear, focused mandates based on realistic expectations.
• Scale or sizzle. Size presents challenges and opportunities at either end of the hedge fund scale. While large funds still attract the majority of institutional assets, and have advantages in building institutional-quality processes, their performance has collectively lagged that of smaller funds. Meanwhile, while small funds may be better equipped to offer competitive returns, emerging strategies, and undiscovered investment talent, they often fail to pass the screens consultants frequently employ when selecting managers.
• Business and marketing acumen. SEI's roundtable participants resoundingly agreed that running a sustainable hedge fund business is as difficult as achieving strong investment performance. Notably, participants also felt that asset growth often depends less on investment performance than on effective marketing and sound business management. Managers need to make strategic use of outsourcing, adopt marketing best practices, and invest more on compelling client communication in order grow their businesses.