The “Global Survey Hedge Fund and Investor Survey 2012” by Ernst & Young, one of the world’s largest professional service providers, found that a significant number of investors (higher than anticipated) increased their allocations to emerging and start-up funds. Forty five percent of the investors believe that emerging and start-up hedge funds could generate better returns and to negotiate better terms.

hedge funds

According to the survey, 67 percent of pension funds and endowments will maintain their current hedge fund allocation, 20 percent of the respondents plan to increase, while 13 percent plans to reduce their allocations.

Thirty percent (30%) of the investors said performance and fees are the biggest obstacles in increasing their allocations to hedge funds. Other obstacles include liquidity needs, risk tolerance, regulations, and complexity.

The survey also revealed that almost two-thirds of pension funds and endowments prefer to invest directly in hedge funds, while 50 percent favor investing through investment consultants. According to Ernst & Young, the number of investors favoring to invest directly had been climbing over the past years, which threatens the business model of funds of funds. Investors who made direct investments could redeem their investments easier, if the performance of the hedge fund did not meet their expectations.

The investors also revealed that the most important criteria in selecting hedge fund managers includes long-term investment performance (3-5 years), management team, clarity and consistency of investment philosophy, risk management policies and oversight, recent investment performance (1-2 years), transparency of portfolio holdings and performance attribution, and fees and liquidity terms.

Based on the survey, Eighty six percent (86%) of the investors responded that performance is the primary deciding factor if they continue their commitment to a particular hedge fund. Investors also expressed their concerns over the operational failures of hedge funds. A majority of the hedge fund managers already developed infrastructures to address the concerns of their investors.

The Ernst & Young survey also found that the cost of the hedge funds’ business operations increased. The survey revealed that hedge funds in North America responded that their business costs surge by 58 percent, 44 percent in Asia, while rising 36 percent in EMEA. The increase in the cost of businesses among hedge funds in North America was due to regulatory changes. The hedge fund managers continue to hire more employees and spend in technology, particularly on compliance (58%) and risk management (54%), and investment management (52%) systems.

The hedge fund managers were able to cover the costs of their business operations despite the increase. They passed the costs to the funds over the past years, but investors are questioning some of the costs, specifically the costs of shadow accounting. Investors (56%) were also concerned about the exposure of hedge funds in the European region. A majority of hedge fund managers increased their investments in compliance functions dedicated in regulatory reporting.