Five “Game Changers” Investors Can Expect From Hedge Fund Sector in ‘13

The Tradex Group Weekly Blog

January 22, 2013

By Michael Beattie, Chief Investment Officer

Five “Game Changers” Investors Can Expect From Hedge Fund Sector in ‘13

New data out from industry sources tells a dynamic story about the hedge fund sector - wealthy private investors are increasingly turning their backs on hedge funds, while pension funds and insurance companies are embracing hedge funds. Why? It's all about the conservative nature of the new era of hedge fund clients, and how the lack of risk is sending rich clients to the exits.

That’s just one trend percolating out of the gate as January 2013 gains some momentum. What are some other key trends hedge fund investors can expect to see this year?

Tradex Global took some time this week to take a look, and we see these five trends at the top of the list:

Mixed Signals On New Regulations? - In a November 2012 survey of 100 global hedge fund managers and 50 major institutional investors by Ernst & Young, fund managers said that while new regulations and compliance mandates from government regulators were “taking a toll” on hedge fund performance, there is widespread industry skepticism over whether or not those new reform rules are working, especially in terms of “protecting investors’ interests and preventing another financial crisis”. Expect heavy lobbying efforts in Washington D.C. and in foreign capitals as the hedge fund industry looks to lighten the load, regulation-wise, to save performance while better serving investors.

Management Compensation An Emerging Issue – Investors who have seen lower rates of return from hedge fund managers are pumping up the volume on hedge fund management compensation. Meanwhile, compensation levels are expected to rise in 2013, according to the HedgeFundCompensationReport.com.  The group estimates that the average hedge fund cash compensation in 2012 was $314,000 – a figure that HFCR said will rise in 2013. Investors in smaller, niche funds aren’t complaining so much, as performance has been relatively solid. But that’s not the case for investors in large funds, the report states. “Despite reports of significant amounts of capital moving to large funds, it seems these small funds are outperforming the market,” said David Kochanek, lead researcher on the hedge fund compensation report.

Hedge Fund Investors Want Transparency, But Want It Gratis – With legitimate questions about exposure, counterparty risk and liquidity concerns, particular over Eurozone fund investments, investors will want greater transparency from hedge fund managers in 2013. But there’s a caveat – there’s little evidence they want to pay for that added “protection”.

’13 Growth Driven By Pension Funds – Data from Agecroft Partners says that 2013 should set a high benchmark for hedge fund assets even though performance in 2011 and 2012, especially from larger funds, has been meager. Driving industry growth in the face of challenging performance headwinds will be increased asset inflows from pension funds, and from an expanding hedge fund investor base due to Congressional passage of the JOBS Act, Agecroft reports. (Per the JOBS Act, hedge funds are now required to generate higher clarity and transparency on key issues like risk and investment process, thus attracting a wider pool of investors.) Expect more pension funds to enter the hedge fund arena, as managers seek to curb downside risk and beef up returns, especially with interest rates remaining low, dampening enthusiasm for fixed income funds.

Smaller Target For Investors – 2013 should see some consolidation among investors, who may concentrate their investment assets to a smaller pool of hedge funds. Expect to see about 90% of all hedge fund investments allocated to a handful of fund firms. But there’s a twist  -that doesn’t mean larger hedge fund outfits will benefit. Increasingly, better performance from smaller funds and a well-honed marketing message from the JOBS Act will “level the playing field” and steer more of those concentrated assets to smaller firms.

There are no guarantees in life, unless you’re a Chicago Cubs fan, but expect the issues above to gain greater prominence as 2013 takes shape.