The Evolving Dynamics Of The Hedge Funds Industry by Ernst & Young
Seismic shift. Profound transformation. These are words that have been used to describe the hedge fund industry in recent years. This year has not been without its turbulent moments, but it has also opened the doors to an environment of opportunity. As managers and investors continue to take on new challenges borne from regulatory and cost pressures, new operational considerations and the war on talent, those that consistently innovate and respond to market demands continue to grow. Efficiency is the name of the game, and embracing technology and data optimization is the new imperative. Change is inevitable, and as the standard operating model fades, we’ve come to realize that the very foundation of the industry is evolving. Challenges will abound, but new avenues will open up as well. From today’s vantage point, an industry in its maturity is looking to the future with healthy optimism.
As you turn the pages of this, our ninth annual Global Hedge Fund and Investor Survey, The evolving dynamics of the hedge fund industry, we cannot help but reflect on the path that has led the industry to its present state, but more so, we look forward to what the future may bring. First, we would like to extend sincere thanks to those managers and investors who provided viewpoints into the direction and development of this survey. Additionally, we would like to express our appreciation to the nearly 110 managers and over 55 investors who gave their time and insight to provide such robust results. We believe that this combination of perspectives provides invaluable observations — both commonalities and differences — that continue to drive and shape our industry.
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The basic economic business model reflects four stages of evolution — start-up, rapid growth, maturity and decline, of which there are two paths, rebirth or demise. The hedge fund industry is in all four stages of this evolution. Start-up funds continue to penetrate the industry. Many funds are experiencing significant growth in their assets under management (AUM). And depending where funds are in the maturity timeline, institutionalization, industrialization or commercialization may be your current state. During this past year, as we have seen for many years, some funds decided to merge with others or close up shop and move on to new ventures. The dynamic nature of this industry has always fostered funds looking at themselves, assessing investors’ needs and the effect of external forces, and remaking themselves in order to grow and stay strong.
There has been a multitude of challenges the industry has addressed in all stages of its evolution:
- Meeting the performance promise: the challenge to perform through a long-running bull market. Several post-crisis factors such as the prolonged low interest rate environment and other government intervention subsidizing traditional economic reality, as well as regulatory changes to managers and service providers have all impacted managers’ operating and investment approaches.
- Escalating stakeholder demands: Investor and regulator demand for enhanced transparency, pressure on fees, and enhanced alignment of interests have amplified to levels not previously experienced.
- The impact of regulatory change: The magnitude of focus and change since the global financial crisis at local, national and global levels has placed a significant burden on people, operating models and technology capabilities.
- Squeeze on operating margins: Partially driven by stakeholder and regulatory considerations, the costs of running a business have escalated dramatically, creating increased barriers to entry for new participants while also straining the economics of even the largest managers.
- Reputational: Negative press from the one-off bad actors who fail to act in accordance with laws, as fiduciaries to their investors or with a lack of general business ethics. Conduct risk and responsibilities as a fiduciary underpin the focus on trust.
2015 stands in sharp contrast to the last decade; today, the concept or definition of a pure “hedge fund” has even been challenged. The blurring of activities and convergence with other segments within the asset management, and more broadly, financial services industry, have made it a significant challenge for hedge funds to brand themselves, and their benefits, clearly in the marketplace. Brand has never been more important as new money flows have been consistently going to the largest, well-known managers, not only in hedge funds but broader asset managers. Yet, start-up hedge funds are experiencing robust investor demand. The investor base has changed dramatically. Just a decade ago, investors were two-thirds high net worth and one-third institutional. Today, the reverse is true. How hedge funds are sold or distributed has changed as well, and the impact of digital and social media will only accelerate further change. The focus on the investor and the “client experience” has never been greater and is clearly in the cross hairs of regulators, globally.
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