The hedge fund industry has largely rebounded from the financial crisis and is responding readily to investor requests for greater transparency, according to a report published by Ernst & Young.
Investors expect greater transparency and agree with most hedge fund managers that the impact of new government regulations will reshape the future of the hedge fund industry, the study reveals.
However, investors and managers both feel that enhanced regulations will not be overly beneficial.
The findings in the report, Restoring the Balance, were compiled by research-based consulting firm Greenwich Associates for Ernst & Young. The annual study polled 104 hedge fund managers who manage some USD585bn in assets and 53 institutional investors representing USD260bn in assets, more than one-quarter of which are invested in hedge funds.
"Hedge funds have recovered sharply from the severe downturn in 2008," says Ratan Engineer, global leader of Ernst & Young’s asset management practice. "The rebound in 2009 was dramatic, and while 2010 may provide less spectacular gains, hedge funds no longer stand at the edge of an abyss. The challenge going forward will be to satisfy investor demands while attracting and retaining talent, and to remain nimble enough to evolve in the face of new regulations, whatever form they might take. We hope the views expressed in the report will stimulate constructive debate – not just between investors and hedge fund managers but throughout the financial community."
Many investors are putting pressure on hedge funds to lower fees and offer more favourable liquidity terms. More than half say that they have more negotiating power now, and more than 40 per cent say that they have pressured their hedge fund managers to lower management and incentive fees. One in three institutional investors says they require greater liquidity than before the pivotal month of September 2008, and three in ten say the maximum lock-up and the maximum gate they will accept is less than it was before the crisis hit.
Of the large proportion of investors affected by liquidity restrictions, just fewer than half (48 per cent) say that they are less likely to invest in a hedge fund that employed strategies to limit redemptions. In contrast, as many as 75 per cent of hedge fund managers believe that investors are less likely to invest with managers who did limit redemptions.
"These results suggest that investors may be far more sophisticated and knowledgeable about the products in which they invest than managers generally believe," says Arthur Tully, co-leader of Ernst & Young’s global hedge funds practice.
Nearly half the funds that imposed restrictions in the crisis have now lifted them. Managers of larger funds, who were more likely to have imposed the restrictions, were the first to lift them, with more than two-thirds saying they have done so. Although some managers lost assets after lifting such restrictions, a significant portion did not. European investors were more likely to exit than investors in the US, and funds of funds were far more likely to terminate a mandate than endowments or foundations.
The hedge fund industry has also seen dramatic structural changes to fund offerings as managers respond to investor demand. Nearly 45 per cent of hedge funds have made changes to fees, liquidity or structure in order to attract new capital. More hedge funds in the US and Europe – 51 per cent and 43 per cent respectively – made changes than did those in Asia (24 per cent). In order to attract capital, many hedge funds have adjusted liquidity terms – 36 per cent allow liquidity more often, and 27 per cent have reduced the minimum lock-up. In addition, nearly one in three funds has lowered management fees, but fewer (16 per cent) say they have reduced incentive fees.