Agecroft Partners’ Steinbrugge sees record assets for hedge fund industry in 2013

Donald Steinbrugge, managing member at
Agecroft Partners, says the increasing allocation of pension funds to alternatives, coupled with regulatory changes, will see assets in hedge funds hit record highs this year.

Agecroft Partners predicts that the hedge fund industry will set a new record for assets in 2013 despite the lackluster investment performance for the industry over the past two years.

This will be driven by pension funds increasing their asset allocations to hedge funds, and a broadening of the hedge fund investor base due to the passage of the JOBS ACT. This conclusion is based on several dominant and emerging trends Agecroft has identified through their contact with more than 2,000 institutional investors and 300 hedge fund organizations during 2012. Below are the eight leading trends that were identified for the hedge fund industry for 2013.

1. Pension Funds will continue to be the largest contributor to growth in the hedge fund industry in 2013

We will continue to see a strong trend of pension funds increasing their allocation to hedge funds in order to enhance returns and reduce downside volatility in their portfolios in order to help manage their massive unfunded liabilities. As a result of declining interest rates, forward looking return assumptions are currently around 3% for fixed income portfolios managed against the Barclays Aggregate Bond Index which currently represents approximately 30% of pension funds’ total assets. With current actuarial return assumptions averaging approximately 7.5%, we will see pension funds shift more assets from fixed income into hedge funds as long as interest rates stay low.

2. Pension funds’ hedge fund investment process will evolve at an accelerated pace

As pensions struggle to enhance returns to meet their actuarial assumptions, we will also see an increase in the speed of the evolution of pension funds’ hedge fund investment process. Historically, many pension plans started with an investment in hedge fund of funds, followed by hiring a hedge fund consultant and investing directly in typically the largest hedge funds with the strongest brands. As they increased their knowledge of the hedge fund industry and added to their internal research teams, they began to make more independent decisions and focused on “alpha generators” which include mid-sized managers. Finally, they evolved into the “endowment fund model” or best-in-breed strategy of investing. In the final stage, hedge funds are no longer considered a separate asset class, but are incorporated throughout the pension fund portfolio.

This whole process use to take over a decade, however recently, some of the larger pension funds have begun to skip the first step of investing in hedge fund of funds by investing directly in individual hedge funds. This will have long-term implications for the hedge fund of fund industry. In addition, we are seeing an increasing number of pension funds utilizing hedge funds in different areas of their asset allocation.

3. Hedge fund of funds industry continues to evolve

The hedge fund of fund market place is approximately 25% smaller than at its peak in the third quarter of 2008. In addition, fee income has declined by over 50% due to downward pressure from large institutional investors. In 2013, the hedge fund of fund market place will experience slight net redemptions where withdrawals by the largest pension funds choosing to make direct investments in hedge funds will be partially offset by smaller and mid-sized institutional investors increasing their allocations to hedge fund of funds along with new high net worth individuals entering the space.

We will continue to see a bifurcation in the industry where a few firms will successfully grow their asset base while others will experience large net redemptions. The successful organizations will fall into two categories which include: 1. Large multi-strategy hedge fund of funds with strong performance that can justify their fees by clearly articulating their differential advantage over hedge fund consulting firms. 2. Niche oriented hedge fund of funds that differentiate themselves by either focusing on a specific strategy, region, fund structure or investor type. Those fund of funds that can clearly articulate their differential advantage will be able to not only grow their assets, but command premium fees.

4. Passage of the JOBS Act will change how many hedge funds market themselves

The jobs Act will help level the playing field within the hedge fund industry by giving investors greater transparency. We will see many hedge funds provide on their websites detailed information on their organization, investment team, investment process, risk controls, performance and information on service providers. In addition, more managers will participate in industry databases making it easier for investors to identify and compare managers within a strategy. Investors will also benefit from more hedge fund managers being interviewed in the media relative to their hedge fund strategies and investment ideas.

The Jobs Act will benefit the hedge fund industry by broadening out the hedge fund investor base and increasing net flows to the industry. Those firms that implement effective marketing strategies to take advantage of new changes in legislation by the JOBS ACT will have a distinct advantage over their competitors.

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