When the California Public Employees Retirement System (CalPERS) announced it was terminating its $4 billion hedge fund program in September 2014, many financial pundits questioned the future of the hedge fund industry. But in a new survey of 100 hedge fund managers, respondents were characterized as “eagerly adapting to changing markets, investors, and products.” In fact, a majority of the survey’s respondents said they expect “a significant shift in their primary sources of capital to pension funds over the next five years.”
Conducted by the Alternative Investment Management Association (AIMA), KPMG International and the Managed Funds Association (MFA), the survey’s results are discussed in a new whitepaper titled Growing Up: A New Environment for Hedge Funds. The paper was authored by AIMA CEO Jack Inglis, KPMG partner Robert Mirsky, and MFA CEO Richard Baker. The survey’s 100 participants represent approximately $440 billion of assets under management (AUM), according to a March 12 AIMA press release.
Hedge Funds in Pensions?
When CalPERS divested its hedge fund program, it looked as though its decision might unleash a domino effect, with more and more public and private pension funds cascading out of their hedge fund investments. This, of course, didn’t happen, and respondents to the AIMA / KPMG / MFA survey certainly don’t think it’s about to: Instead, they said they expect institutional investors, including pension funds, to continue to eclipse high net-worth individuals as primary sources of hedge-fund investment. Longer-term, respondents projected public-sector pension and sovereign wealth funds will account for over 25% of hedge fund capital inflows by 2020.
“The days of hedge funds simply being an investment tool for high-net worth individuals are over,” said Mr. Baker. “Institutional investors like pension plans, university endowments, and charitable organizations now make up nearly 65% of the industry’s assets.”
CalPERS ended its hedge fund program due to scaling issues, not poor performance or high fees. Hedge funds have been underperforming in the bull market that started in 2009, but that’s to be expected, since hedge funds are by definition “hedged,” with less beta exposure than passive indexes. And while the “2 and 20” fee structure – 2% of AUM and 20% of trading profits – has come under fire, CalPERS was large enough to warrant a customized fee structure. In addition, almost 70% of the survey respondents said they offer or plan to offer customized solutions for large investors like pension funds, with more than two-thirds saying they planned on using “specialized fee structures” in order to attract investment.
“Our survey shows the transformative change that is impacting every aspect of hedge fund management, from product mixes and fee structures through to markets and investor types,” said Mr. Mirsky. “The managers we spoke to around the world recognize that the industry must continue to adapt and adjust strategies in order to thrive.”
The Role of Liquid Alts
New hedge-fund strategies highlight customization and new markets, including the advent of “liquid alts,” which provide access to alternative strategies for non-accredited retail investors, as well as added liquidity for institutional and high net-worth investors. Thirty-eight percent of respondents said they either had or were developing an alternative UCITS (Undertakings for Collective Investment in Transferable Securities Directives), roughly the European Union equivalent of a mutual fund. Twenty-seven percent of respondents said they had or were developing a “40-act” alternative mutual fund for the U.S. retail market.
The uncertain regulatory environment was one concern shared by most respondents. More than three-fourths of survey participants cited regulation as “the biggest threat to the growth of the hedge fund industry,” and European and Asia Pacific respondents were particularly concerned. But according to Tom Brown, Global Head of Investment Management for KPMG, “while compliance obligations have increased operating costs, there are signs that these costs are flattening out, and fund managers can put more of their attention on growth.” This is good news, according to Mr. Brown.