After taking a beating in 2008, the global hedge fund industry has achieved an impressive comeback. Global assets invested in the hedge fund industry are currently close to $2 trillion and continue to return. Investors are smarter, more cautious and are demanding protection, performance, transparency and quality. Investment managers are striving to gain back investors’ trust and loyalty and can no longer hide behind the “proprietary” curtain. Regulators are being challenged to get more involved to ensure the right balance is struck between all players. As a result, the industry has undergone major changes and will continue to do so in the years to come.
From an investor’s perspective, there is a big demand for transparency. Funds are sharing a lot more information about leverage, risk management and geographical distribution of their investments. Funds are diversifying risks by arranging, for example, multiple third-party custodians to hold assets, and financial information that is being shared is often now subject to independent review and verification. In many cases, back office functions and valuations once done by the asset managers are now being handled by third party administrators and valuation firms. “While demands have increased, the appetite for cost control and improved performance has not diminished,” says Chad Critchley, a partner at Ernst & Young Ltd. Service provider fees are under pressure and all players, including asset managers, are looking at cost effective ways of attracting and retaining capital.
With regard to investment managers, their main challenge is to attract and retain capital by re-establishing trust and loyalty from their investor base. Managers are spending a lot more time with investors, ensuring their needs are met, questions answered, and concerns mitigated. Asset managers are also revisiting their compliance infrastructure and preparing for increased regulation. There is a rise in the C-Suite with managers hiring chief compliance officers, chief technology officers, chief risk officers and so on. Managers understand that these changes and investments are needed to keep up with the increase in reporting to investors and regulators. All of this has caused a fairly high barrier to entry reflected by the consolidation we are seeing in the industry. “Start-ups that don’t have a sophisticated infrastructure and reputable service providers will have a tough time in today’s climate,” says Jessel Mendes, a partner with Ernst & Young Ltd.
From a regulatory perspective, as expected, a raft of globally-relevant regulation is about to impact the industry. “There is no escape,” says Critchley. “It is important, however, that all participants push for a level playing field. This industry is entrepreneurial and it would be a shame if that was diminished by forcing regulation that is punitive, protectionist, and anti-competitive.” It is also important for all to understand that the industry is global. Prime brokers, asset managers, investors, and related service providers all operate on a global basis. “Having different regulatory playbooks for different parts of the world fractures the globalization of the industry and would, in my opinion, not be in its best interest,” Mendes adds.
Finally, Bermuda has not been immune to the challenges of the hedge fund industry. However, it has weathered the storm and continues to see renewed interest in its hedge fund industry. Government, the Bermuda Monetary Authority and industry participants are all proactively working together to ensure investors and asset manager interests are met. “Bermuda has always offered an effective business environment striking the right balance between regulatory excellence without stifling entrepreneurial spirit,” says Mendes. It has been in the hedge fund game for a long time and boasts a sound track record. It is well positioned to capitalise on the next wave of this dynamic industry.
Jessel Mendes and Chad Critchley are partners in the Financial Services Office of Ernst & Young. Both are based in Bermuda.
The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young.