This changing attitude among managers is being driven by the growth in the sector, increased competition and rising demand from institutional investors.
According to a survey by London-based consultants Kinetic Partners, although performance is still hedge fund managers’ priority, other matters related to infrastructure and outsourced operations are very high on their agenda. David Butler, founding member of Kinetic, said the survey showed the hedge fund community is now taking the need to improve their infrastructure very seriously, as investors are now performing significantly more due diligence.
The survey, based on responses from hedge fund managers operating in the UK, found that although most agreed that the cost of outsourcing operations – mainly fund administration and accounting – was reasonable, service levels could be improved if they were more actively monitored. For instance, some managers admitted that despite having implemented disaster recovery plans, they had failed to test them.
The growth in the industry is also having an impact on the way hedge fund managers run their businesses in terms of product development and human capital. First of all, as more players break into the market, managers are finding it more difficult to differentiate themselves from competitors. At the same time, attracting new talent is becoming quite a challenge, with fewer managers willing to move firms at a realistic price. These two factors are regarded as important inhibitors of future growth.
Institutional investor requirements in terms of governance and risk control are forcing managers to think about the need for improvements in this area, as David Butler explained.
“I think that managers and investors influence each other,” he said. “What we are seeing now is a level of maturity among the largest players. With that maturity comes a need and an understanding for risk management processes and procedures. With the education of investors - and the influx of institutional assets - comes another driver for risk management processes.”
Although in the past lack of transparency in the sector has been highlighted as one of the factors keeping institutional assets away from hedge funds, things are gradually changing.
“I don’t think transparency is going to be a key driver for anything in the industry because properly educated investors would understand that they have invested in sensible, properly educated managers,” Mr Butler said. “What is really driving the industry is more risk management processes. Those processes and procedures are what investors are looking for, more than transparency per se.”
In addition to high-net-worth individuals and institutional investors, fund of funds remain one of the largest investors in hedge funds. However, the survey found that the larger hedge fund managers believe that fund of funds popularity is increasing risk in the sector due to higher leverage, the short-term nature of their investment horizon and their lack of loyalty.
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