2014 has seen a volatile macro environment, and investors and fund managers alike have predicted that the returns this year will not exceed the returns achieved in 2013. Preqin looks at the growth in hedge fund assets in H1 2014 and assesses where this capital has come from.
As we entered the year, hedge fund managers and investors were feeling positive about the prospects of growth in the industry, and Preqin predicted that if managers could successfully navigate the complex regulatory environment and generate acceptable returns then the assets under management of the sector would grow again. With performance of the asset class becoming less acceptable to investors and regulatory concerns becoming more prominent as the AIFMD deadline passed, Preqin turned its attention to hedge fund managers. In June, Preqin conducted surveys with over 100 hedge fund management groups to delve deeper into the first half of the year; how successful have managers been at fundraising and where has any fresh capital come from?
Increased Competition and Capital Flow
Seventy-three percent of hedge funds that participated in the Preqin study reported that they have seen increased levels of competition from their peers when raising capital from investors. A quarter of fund managers reported that this increase in competition was significant. With over 12,000 hedge funds competing for capital, and much of the inflows over recent years going to just the larger hedge funds, it is clear that fund managers are finding it increasingly difficult to stand out from the crowd.
In addition, there has been a proliferation of new structures to take advantage of different groups of investors looking to gain access to hedge fund strategies, as well as to give a fund manager a competitive advantage in the crowded marketplace. A quarter of all hedge fund managers that participated in the June surveys offer alternative UCITS vehicles to investors, and 22% offer alternative mutual funds. Hedge fund managers are divided in their outlook on how the proliferation of these products will change the industry going forward. Thirty-one percent of fund managers believe that these new structures will lead to increased competition with the offshore pooled model, which will in turn reduce the inflows to these pooled funds. However, 37% believe the opposite and that the expanded options for investment in hedge fund strategies will in turn lead to more investors considering the asset class as a whole, which will lead to an increase in inflows for all. Of the 10% of fund managers that feel that the offshore model will need to change as a result, most respondents believe changes will need to be made specifically to keep up with the regulated and transparent nature of the liquid alternatives which are entering the market.
When considering the changes in assets under management in H1 2014 by fund managers which offer each product type, the largest proportion of fund managers (64%) reported that they had witnessed inflows into their pooled hedge fund products. Sixty-one percent and 50% of fund managers that offer alternative UCITS and mutual funds respectively reported inflows into those products. This indicates that although there has been a wave of new liquid alternatives products flooding into the industry, managers have been more successful in attracting assets into their “traditional” hedge fund products. Therefore, this could signal that the 37% of fund managers that believe that the expanded options will lead to inflows for all types of hedge funds may be correct in their outlook.
Private Capital Dominating Inflows
Continuing a trend witnessed over 2013, inflows from sources of private wealth such as family offices, wealth managers and high-net-worth individuals have outpaced that of institutional investors in the first half of 2014. Fifty-eight percent of hedge fund managers, whose investors include family offices and wealth managers, and 59% of fund managers that have high-net-worth support reported that they have had inflows from these investors in the first half of 2014.
Preqin estimates that the total assets in the hedge fund industry stands at $2.90tn (as of 31 July 2014). At the end of 2013, we estimated that 65% of hedge fund assets came from institutional investors; however, as a result of the inflows from private capital sources over the past 18 months, this has fallen slightly to 63% today. Despite this, institutional investors such as public pension funds, funds of hedge funds and foundations continue to invest more capital in hedge funds. Across all investor types, more fund managers reported that they had seen an increase in capital from this group than those fund managers that reported they had seen a decrease.
Rise of the Retail Investor
Forty-three percent of hedge fund managers reported that they have capital from retail clients channelled into their funds. Forty-seven percent of these fund managers reported that the amount of capital these retail clients invested in their funds had increased in the first half of the year. Over the past 10 years, the hedge fund industry has undergone many changes as a result of the influx of capital from institutional investors. The institutionalization of hedge funds has led to asset management firms focusing more on functions beyond investment strategy, such as investor relations, back office and risk operations. These changes in turn have meant that more institutional investors have made their first allocations to hedge funds, as they become more comfortable with investing in an asset manager which can meet their service requirements and generate attractive risk-adjusted returns.
Eighty-two percent of the fund managers that participated in the study believe that more capital will flow into hedge funds from retail clients. This “retailization” of the industry has already led to many changes in how hedge funds are distributed and the types of funds on offer, particularly with regard to the rise of liquid alternatives in the past few years. As the hedge fund industry continues to grow, both in terms of the amount of assets managed in the sector and the number and different types of clients which invest in these hedge fund strategies, hedge fund groups will need to continue to grow and diversify. This diversification is likely to be across the types of products and strategies they offer, in order to appeal to different client types, as well as through growing internal teams and outsourcing certain functions in order to meet the needs of different investors for transparency, risk reporting and other investor relations functions.
Outlook
Although the first half of the year has been rocky, with performance proving underwhelming and investor satisfaction with the industry starting to wane, it has been a successful one for many managers in terms of fundraising. Across all types of hedge fund products offered by the managers that participated in this study, more firms reported that they had seen inflows than had seen outflows. The growth in the amount of assets invested by private sources of wealth, coupled with the continued support of institutional investors has seen the industry grow to $2.90tn (as of 31 July 2014). Interest from a wider group of investors, including those in the private wealth arena and retail clients, is leading to a proliferation of new structures, in particular liquid alternatives, to cater to new markets. This in turn gives more product options to all hedge fund investors and as a result has led to further growth in assets under management in the hedge fund sector.
Despite any concerns from investors and fund managers as a result of industry performance in the first part of this year, the outlook for the rest of the year looks good: 77% of the hedge fund managers that participated in our June study stated that they believe the industry’s assets under management will grow further in the second half of the year.
As the industry grows more complex, both in terms of the broadening groups of investors which participate in the sector and the strategies and products on offer to these investors, it is more important than ever for fund managers and investors alike to stay on top of the developments in the hedge fund market in order to remain competitive and to gain access to the best fund option for their portfolio.
This is an excerpt from Hedge Fund Spotlight – August 2014. To download the full report, click here.
