After a successful decade of expansion, the hedge fund industry is having to come to terms with an u...
After a successful decade of expansion, the hedge fund industry is having to come to terms with an unpleasant development: the creep of regulation.
In the US, the SEC introduced its registration rule, covering managers based not just onshore but offshore as well. In the UK, the FSA has stated its intention to monitor asset values closely as well as levels of disclosure to hedge fund clients. At the same time it is looking to authorise funds of hedge funds.
The comparative lack of regulation until now has no doubt speeded up the expansion of the industry, allowing funds and businesses to set up and try their hand, and many top quality managers and firms have emerged from this environment.
But once the industry gets beyond a critical mass it is hardly surprising onshore regulators are keen to start taking an interest. Any further expansion is likely to be into the retail space and the ultimate investors behind many institutional deals are consumers. When a big pension fund makes an allocation to a hedge fund, it is an institution big and ugly enough to look after itself buying an alternative asset class. However, if that investment goes wrong there could be a lot of pensioners with a funding problem on their hands.
Whatever gripes the long-only fund industry may have about political interference or regulators such as the FSA, there is no doubt the industry would have been nowhere near as successful if it had been unregulated and the Government never got around to inventing the Pep or Isa.
Perhaps the issue for hedge funds and investors should not be about regulation, be it onshore or offshore, but about the asset class's ability to generate decent returns and value for money in the future.
The idea of absolute return investing is very popular but beating cash has not been that difficult in a three-year bull market which has seen global indices make a spectacular recovery from the horrors of 2000-02. When equity markets cease to fizz, just how easy will it be to beat a Libor plus benchmark? And how disappointed will investors be if their manager cannot do so?
Another potential source of worry is the impressive amount of financial engineering going into hedge fund products or derivatives. Guarantees and multi-manager approaches all come at a cost and while the assertion from many providers is that these are adding value to investors, the chances are some of them will prove to have added cost.
A final area of concern would be just how keen on gearing some institutional hedge fund investors are becoming. It is a strategy that has worked very well for a number of private banks of late, but will it do so if the market falls? No doubt these investing organisations are sophisticated with wonderful risk controls, but that is probably the way many of the institutions that invested in split capital investment trusts would have described themselves back in the late 1990s.
The fundamental issue for hedge funds is, will they make decent returns for what investors consider a fair price? If this is the case the industry will thrive, regardless of regulation. In fact regulators will help it to succeed because they like to be associated with a success story just like everyone else.
If the industry disappoints then neither lack of regulation nor application of sympathetic and wise regulation will help to revive it.
Tanya Bird, editor
An added tier of asset management can of course deliver additional benefits for certain investors, writes Graham Bentley - just be sure you can justify it to the regulator and, especially, the client
The government is "in daily contact" with industry figures over the pensions dashboard as it prepares for the roll-out and its feasibility report, Guy Opperman has said.
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From 1 April 2019
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