Growth for hedge funds, but investor demands changing – Deutsche report

The global hedge funds industry can expect renewed growth in 2013 but changing investor demands will re-shape the industry, favouring some providers and challenging others, according to the latest annual Alternative Investment Survey from Deutsche Bank.

The bank’s 11th annual survey, this time of 300 investor entities worldwide managing more than $1.2 trillion in hedge fund assets, showed investors predict 11% growth for the industry in 2013, with assets reaching $2.5trn by year end.

Barry Bausano, Global Co-head of Prime Finance at Deutsche Bank said the hedge fund industry is evolving as investor expectations and manager returns more closely align.

Participants in the survey represented more than half of all assets under management in the sector worldwide. Over half of those polled individually manage and/or advise over $1bn in hedge fund assets, with 10% managing $10bn or more. Sector inflows in 2013 are projected at some $123bn over the year.

Other findings are that hedge funds are no longer perceived as a stand-alone asset class. Institutional investors have moved from a traditional asset class allocation to a risk-based approach. A quarter of institutional investors have adopted this approach and half of consultants recommend it to clients.

Anita Nemes, Global Head of Capital Introduction at Deutsche Bank said: “Investors are increasingly looking for steady and consistent returns as they balance portfolios according to a risk based, rather than asset class approach. Top performing managers continue to dominate, but besides performance, aligning interests with those of the investor is also critical in order to win attention from an increasingly institutional investor base.”

Two thirds of investors feel hedge funds have performed as expected or better in 2012. For 2013, 65% of investors and 79% of institutional investors are targeting returns of 5-10% from hedge funds.

Successful fee negotiation involves compromise, whilst investors commit to top performing managers. Almost 80% of investors pay an average management fee of 1.5%-2% and three quarters pay 17.5%-20% for performance. Only 29% of investors who negotiate fees are successful more than half of the time.

Institutional investors dominate hedge fund AuM. Whilst 57% of private banks decreased hedge fund AuM, almost 70% of pension funds increased their allocations.

Almost half of pension funds expect to increase allocations by $100m or more in 2013.

The survey also found that “the demise of fund of funds has been exaggerated”, with evolved business models attracting institutional capital. 29% state that over half of new business in 2012 was for bespoke portfolios, whilst 58% of end-allocators state the main benefit of fund of fund allocations is to access niche managers, including smaller or younger funds.

Comment with the survey explained: “In this year’s survey we let go of old expectations and introduce the new, all the while acknowledging that the pillars of hedge fund investing have remained the same.”

Among the changed expectations are:
Old: “Industry growth driven by family offices and private banks”
New: Industry growth backed by institutional investors
Industry growth since 2008 has been largely driven by increased institutional participation, with 2012 being no exception. Whilst 57% of private banks decreased hedge fund assets under management (“HF AUM”) in 2012, almost 70% of pension funds increased their allocations. Institutional-led growth is set to continue in the coming year, with almost half of pension funds expecting to ramp up allocations by $100mn or more in 2013.

Old: “Hedge funds may get an allocation from the ‘alternative bucket’ within institutional portfolios”
New: Hedge funds no longer viewed as a separate asset class
Institutional investors are looking beyond the traditional asset allocation approach of bonds, equities and alternatives, and instead moving towards a risk-based approach. Indeed a quarter of institutional investor respondents have adopted this approach, and half of the consultants are recommending it to clients.

Old: “Hedge funds offer outsized returns in all market environments”
New: Hedge funds expected to deliver steady, predictable return streams
In 2010, more than half of investors were targeting double-digit returns for their hedge fund portfolios.1 Just three years later, this percentage has fallen to less than a third. Nearly two thirds of respondents feel that hedge funds performed as expected or better in 2012, after the HFR Fund Weighted Composite index returned 6.2% for the year.2 For 2013, 65% of investors, and 79% of institutional investors are targeting returns of 5-10% for their hedge fund portfolios.

Old: “Hedge fund fees will collapse”
New: Greater alignment of interest between managers and investors
Almost 80% of investors continue to pay an average management fee of 1.5-2.0%, with over half of these investors paying 1.75-2.0%. Three quarters of investors pay an average of 17.5-20% for performance. Investors increasingly recognise that successful fee negotiations typically involve a compromise: only 29% of investors who negotiate fees are successful over 50% of the time, and half of these investors have their capital locked up for at least 2 years and manage at least $2.5bn in HF AUM. Concurrently, 83% of investors suggest that managers should use a hurdle rate. Whilst ongoing, fee negotiations are not the most prominent theme this year. This is substantiated by the finding that consultants do not place “downward pressure on fees” in their top 3 largest trends amongst their clients.

Old: “The fund of funds model is broken”
New: Funds of funds attract institutional capital with an evolved business offering
29% of funds of funds state that over half of new business in 2012 has been for bespoke portfolios, whilst 58% of end-allocators state that the main benefit of their fund of funds allocations is to access niche managers, including smaller or younger funds. Furthermore we are starting to see a convergence between funds of funds and consultants.

 

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