Wednesday, June 21, 2006

Not With a Bang But a Whimper

  As you may be aware, I've blogged before about what I consider to be the inevitable restructuring of the alternative investment community. This restructuring is inevitable as excessive profits are not sustainable in an environment with relatively low barriers to entry - those who have ever worked at a hedge fund know exactly what I'm talking about. What is less certain is how this shakeup will occur.

I see three possible scenerios: 1) a crash caused by fund managers taking on extraordinary risk in order to cull the returns demanded by their clients - other factors would be at play as well. 2) textbook consolidation led by commercial banks, increased economies of scale and the subsequent lowering of fees. 3) a soft landing caused by a flight of clients fed up with high fees and average to below average returns.

Consider the following from the Financial Times:

Hedge fund managers are increasingly refusing to make risky investments for fear of losing customers and their sky-high fees, according to GAM, the world's biggest hedge fund firm. GAM, a fund of hedge funds specialist based in Zurich, said it was hard to find managers prepared to take the levels of risk needed to produce the high returns wealthy investors demanded.

David Solo, chief executive of GAM, which manages $55bn for private clients including $23bn in hedge funds, said the change in managers' risk appetite stemmed from their success in raising money from pension funds, endowments, insurance companies and other institutional investors.

With typical management fees of 2 per cent a year on large amounts of assets, there was more incentive to retain assets through cautious management than to seek additional performance fees from outsized returns.

The sector's profile has changed as institutions have poured money in and driven worldwide hedge fund assets to more than $1,000bn. Institutional investors such as pension funds have demanded that hedge funds in which they invest reduce their risk levels.

With mature hedge funds taking a conservative approach, GAM has been forced to invest in start-up hedge funds, typically staffed by former investment bankers who are prepared to take big risks until their fund reaches critical mass.

Hedge fund performance had also been hit by the weight of money coming into the industry, which had led to "overcrowding" in many strategies, he said.

Interestingly, the article says that mangers are, "refusing to make risky investments for fear of losing customers and their sky-high fees." - this is the crux of their problem. What kind of returns can a hedge fund produce by taking less risk? Put another way, will clients pay an alpha premium for beta returns? I don't think they will.
Posted by Trade Monkey :: 9:29 PM :: 0 comments Perma-Link

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