How are hedge funds coping with the new market realities?

Comment & Analysis: How are hedge funds coping with the new market realities?

“The day of 2/20 is now but a footnote in the annals of hedge fund lore”

This year has been challenging for the industry. Our clients have experienced negative net capital flows through the first three quarters in the amount $30bn representing approximately 3.5% of total assets under administration.

In total, our clients have seen approximately $158bn in gross redemptions during 2016 which is similar to prior years.

Hedge Fund Strategies

These capital flows have been documented in various media outlets which take great pleasure in reporting doom and gloom for the hedge fund industry.

Evidently, these outflows are on the back of lacklustre performance numbers posted by the industry at the end of last year which continued into the first few months of this year.

What is interesting to observe is that projected capital outflows for the end of the year are approximately 2.5% at time of writing.

That is very much in line with (or even less than) what Citco’s clients have experienced over each year end since 2010.

What remains to be seen is how much of this money will flow back into hedge funds at or subsequent to the year-end.

In the past, we have witnessed a strong correlation, typically with a three-month delay, between capital flows and positive/negative returns. It will be interesting to see how this holds up given the positive returns we have seen in recent months.

 

OUTSOURCING

One of the primary consequences of asset contraction is that managers’ margins have been squeezed. This is on top of the ever increasing compliance costs experienced on the back of heightened regulatory pressures.

Managers are adapting to this new reality with a razor sharp focus on their front of house staff. They are also looking at what their back office staff are doing and at ways to further leverage external providers, including administrators.

Managers recognise that administrators have deployed superior technology solutions to meet some of the challenges. The administrator’s scale brings process control to the solutions being delivered and for those that are more sophisticated the ability to continue enhancing the core technologies on a frequent basis.

The chances are that given an administrator’s scale and breadth, they have been presented with challenges in the past that they have already solved, long before they have been encountered by a manager. This is where the real revolution in outsourcing is coming from today.

 

FEES

It is also worth mentioning the trends we are observing in the fee world. Competition is fierce for those strategic investor dollars. We have all read about some marquee names that have sought to be more creative in their fee structures to retain their longer term and most strategic investors.

As you can see from the data below, the average management fees charged have continued to drift lower year-on-year. On average funds/classes/managed accounts launched in 2016 are averaging fees of 1.3% compared to 1.4% – six years ago, representing a reduction of approximately 8%.

For incentive fees, there is no discernible trend when you look across all strategies. Movements year-on-year have depended more so on the particular strategies we have seen launched in that year.

The one thing that is clear to everyone is that the day of 2/20 is now but a footnote in the annals of hedge fund lore, especially in light of the other elements that are being factored in to the more recent launches such as hurdles, claw backs and investor-level gating features.

 

Published in HFMWeek (15-21 Dec. 2016 Edition).

Our contacts

Kieran Conroy

Kieran Conroy

Co-Head of Fund Services Division

T+1 416 969 3900
Ekconroy@citco.com