Disgruntled wealthy investors will help drive big changes to hedge funds and should insist on tough scrutiny of institutions underwriting structured products after a period of losses and bankruptcy of firms such as Lehman Brothers, a senior private bank executive said.

Hedge funds - frequently used by private banks on behalf of clients - have suffered a poor year so far. Hedge Fund Research, the US fund tracker, said its composite index of returns fell more than 10 per cent between early January and the end of September. Even so, that compares with a loss on the MSCI World Index of developed countries’ equities of -24 per cent.

Although hedge funds have not on average fared as poorly as a long-only investment in stocks, they have lost their once-proud status as able to make money in all markets, Andrew Popper, chief investment officer of SG Hambros, told a private banking conference hosted yesterday by WealthBriefing and Lexis Nexis.

“Hedge funds have been a big disappointment this year and not surprisingly we have seen a significant wave of withdrawals from funds. However, rumours of the demise of the hedge fund industry are somewhat exaggerated. There will be a restructuring of the industry,” Mr Popper said.

In particular, he predicted that investors, with stronger bargaining power now that hedge funds have been keen to stem redemptions, will be able to pay lower fees. Investors will also migrate to what are called managed accounts. On these platforms, the investor owns the actual assets via the account, are transparent, and provide preferential liquidity for clients. Accounts can offer daily or weekly access to funds, which is a big attraction to investors nervous about long lock-in terms for many hedge funds.

Traditional reluctance of hedge fund managers to go onto managed account platforms is vanishing, Mr Popper said. “This is a significant development in the hedge fund industry,” he told the conference.

Structured products, meanwhile, have come in for negative publicity since the bankruptcy of Lehman Brothers in September, as this bank underwrote a raft of such capital-protected vehicles, leaving investors potentially out of pocket.

Asked what the implications of the Lehman case were, Mr Popper said it would encourage wealth managers to insist on checking the counterparty risks involved in structured products. One option for banks would be to create a special purpose vehicle that would stand behind these products, be legally separate from the product issuer, thereby protecting the client’s capital. However, this would make such products more complex, Mr Popper said. He said this was a paradox since investors were likely to “shy away” from complex products that neither they nor probably the banks themselves understand.

But structured products had many attractive features, such as enabling clients to access otherwise difficult-to-enter markets, avoid crippling capital losses and fine-tune their exposure to certain markets, Mr Popper told the conference. 

The development of a secondary market in structured products, while by no means perfect because issuers typically are the only institutions able to buy them back, can help to improve price efficiency, Mr Popper added.