Notwithstanding a difficult 2008, the importance of the asset class and its continued role in building a high quality diversified investment portfolio is not to be underestimated. Hedge funds remained one of the best performing asset classes in relative terms in 2008, and the industry has returned to positive performance this year across most strategies. Institutional investors do recognise this, and recent research by Barclays Capital suggested there will be up to $50bn (£30bn) of new allocations before the end of 2009.
What we are seeing is that the majority of this money is likely to come from institutional investors, particularly pension funds. In fact, anecdotal evidence tells us that the recent shake-out in the sector, combined with some unique investment opportunities, means there has never been a better time to allocate funds to the sector.
At the same time, it must be recognised that a number of lessons have been learned from the recent turmoil, and investors should expect some changes in the way the industry is structured.
Investors must demand more from the industry – but what?
The most fundamental lesson is that managers must embrace alignment of interest with investors in three key areas:
■ liquidity – illiquidity is not necessarily a bad thing and a number of the most interesting and rewarding opportunities in the coming period will be highly illiquid. Pension funds, by nature of their long-term investment horizons, are perfectly placed to exploit these opportunities. What is vital is that the liquidity offered is relative to the strategy being pursued, and that mismatches between the prospectus liquidity offered and the liquidity of the underlying investments held is rectified. Pension funds must ensure their investment portfolios’ liquidity conditions reflect the underlying investment opportunity;
■ fees – in general, there is downward pressure on fees. However, of greater importance is the need for pension funds to push for increased alignment in the manner in which fees are taken. We will see fees increasingly being taken over a period of time more aligned with investors’ investment horizons;
■ transparency – we are not suggesting that details of every trade within every fund must be available for scrutiny, as funds would lose a significant competitive advantage and the information would be of little use to investors. But an investor should be able to fully understand what they have invested in, and portfolio transparency should flow through client reporting to allow for better investment analysis and understanding by clients.
The hedge fund landscape, at both multi-manager and individual fund manager levels, will undoubtedly be one of fewer, stronger players, where investors and hedge funds both have a responsibility to work to align their interests for the future.
