Regulation sparks distribution awareness. A rapidly evolving regulatory environment has focused minds in the hedge fund industry. Systematically identifying and targeting sales channels and targets used to be an opportunistic rather than strategic activity at many hedge funds. But in the wake of new regulation, many firms are developing sophisticated processes to decide which investor channel or channels, and which markets to target and, consequently, which regulatory regimes they are prepared to address.
Regulation is opening up the opportunities for hedge funds distributing in Europe, the US and Asia. For example, the Chinese currency is slowly opening up to internationalization and Beijing is reducing investment barriers. Such changes bring investment opportunities. Even the EU’s Alternative Investment Fund Managers Directive (AIFMD) represents an opportunity for firms which may wish to avail themselves of some of the private placement regimes in more liberal Member States, or choose to fully comply and thereby gain a passport to sell funds across the EU.
In his first-quarter letter to investors of Greenlight Capital, David Einhorn lashed out at regulators. He claimed that the market is "fractured and possibly in the process of breaking completely." Q1 2021 hedge fund letters, conferences and more Einhorn claimed that many market participants and policymakers have effectively succeeded in "defunding the regulators." He pointed Read More
AIFMD has changed the distribution game for hedge funds. It has been a catalyst for firms to reconsider their distribution strategies – more than three-quarters of managers in the survey say they have changed where or how they market non-EU Alternative Investment Funds (AIFs) to EU investors in the wake of AIFMD. If the AIFMD passport is extended to allow EU Alternative Investment Fund Managers (AIFMs) to market non-EU AIFs to professional investors across the EU, many EU AIFMs say they would apply for a passport. In the meantime, a good number of non-EU fund managers that are marketing in the EU have decided to create their own EU AIFMs or become sub-advisers for EU AIFMs instead of opting to use a non-EU AIFM.
It is clear that scale provides cost advantages that enable investment in meeting regulatory requirements, and this deepens the divide between the large and small managers. Larger managers can attract more flows through more complex and costly distribution opportunities whereas the small tend to stay localised, with more limited distribution focus.
Increasing Sophistication of Investors
The hedge fund industry has experienced strong growth since its inception and this growth shows little sign of slowing. However, this growth is accompanied by an increasingly demanding, sophisticated and influential investor base.
Growth in the industry is strongly supported by the survey: well over half of hedge fund managers (61%) report that assets are rising. The trend is even stronger among larger managers – two-thirds of mid-sized firms report rising assets and all of the large firms surveyed say assets are on the increase.
Investors are increasingly aware that the sheer volume of assets they are pumping into hedge funds gives them considerable influence over how those assets are managed. As PwC identified in the paper Alternative Asset Management in 2020, assets will only flow to the most compelling strategies and the most professionally managed firms. Investors will expect more from their hedge fund providers – more tailored, outcome-based hedge fund products which provide capital preservation and upside opportunities.
It is clear from the survey that performance remains the key sales factor. However, performance must go hand-in-hand with a strong brand, appropriate fee structures and a focus on good service and tax issues.
Excellence in all these areas must be accompanied by sound sales strategies and it is clear from the survey that direct engagement is the best medium for this. However, sales lead times can be long – nearly a quarter of survey respondents report that lead times are over a year. Such long lead times are likely to have a disproportionately large impact on small and start-up funds, which depend on rapid asset growth to survive.
Going forward, considerable thought will be applied to each and every fund launch. Nearly half of the managers in this survey anticipate launching a hedge fund in 2015-16. As investors become more demanding and require greater customization, the research and business development activity before a fund launch will intensify. Every product must be thoroughly vetted – for potential performance, for attractiveness to the market and for potential profitability.
Liquid alternatives: a rising tide?
The growth in liquid alternatives – primarily UCITS funds in Europe and mutual funds registered under the Investment Company Act of 1940 in the US, known as ’40 Act funds – has been prolific. With greater transparency, a strong regulatory environment, appealing liquidity terms, often lower fees and the ability to access a range of alternative strategies, growth in liquid alternatives is unsurprising. The survey bears this out, with 81% of firms that manage UCITS funds reporting rising assets under management (AuM). Meanwhile, some 87% of US managers of liquid alternative funds in the survey say AuM is rising in these strategies.
There are likely to be many more liquid alternative funds, with half of survey respondents in the UK planning to launch one in 2015-16. Nearly a third of the US firms are planning a liquid alternatives launch. However, just 14% of the continental European firms plan to launch a liquid alternatives fund in 2015-16.
Liquid alternatives operate in a densely regulated environment, which is more restrictive than the traditional hedge fund environment. Investment managers may need to alter their investment strategies to make sure that their investment portfolios are managed in compliance with regulations, and they will need appropriate infrastructure. In addition, liquid alternatives may have to be tailored for fund supermarket ranges, distribution platforms and other distribution channels, which involves significant negotiation between investment manager and distributor. This can result in a compromised alternatives distribution strategy.
Regulation sparks distribution awareness
What a difference ten years makes. A decade ago, hedge funds could target and sell to qualified or professional investors virtually anywhere in the world with relatively few constraints. While some regulations existed in certain jurisdictions, they were not highly prescriptive and focused primarily on qualifications of investors.
The situation is radically different in the post-financial crisis era, and most hedge fund firms worldwide are faced with significant regulation which has increased their compliance and reporting workloads, added to their cost bases and, in many instances, restricted their ability to sell their funds.
At the same time, the aftermath of the financial crisis has also led to policy-making which has opened up opportunities to fill some of the funding gap that has emerged.
In addition, regulation has been enacted which aims to support the growth of the asset management sector and, particularly, alternatives. This is manifest in Asia, where policy-making is attempting to drive asset growth. In Singapore, the Enhanced Fund Manager Regime has brought alternative funds under the same regulatory umbrella as traditional funds, increasing their distribution scope. Meanwhile, Korea has expanded the profile of investors eligible to invest in hedge funds and lowered the minimum investment. India introduced an Alternative Investment Funds regime, while Thailand is currently undertaking a public consultation to introduce regulation for alternative investment funds.
In the US we have seen measures such as the Jumpstart Our Business StartUps Act (JOBS Act). Since the financial crisis, the US and the EU have also encouraged infrastructure investment and other investment aimed at stimulating economic and corporate growth.
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