Investment Strategies

Hedge Fund Industry Slowly On The Mend, Challenges Remain

Tom Burroughes Editor London 22 October 2009


There are further signs that the hedge fund sector has recovered from its poor year of 2008, with new product launches and signs of new firms entering the field.

The world’s hedge fund sector is fighting back even while the wealth management industry looks nervously at constant threats of new regulations and remains mindful of last year’s big losses.

There have been a number of hedge fund launches in recent weeks, in some cases with funds embracing the pan-European UCITSIII wrappers to make hedge funds more attractive to wary investors. Launches of funds have come from HSBC Alternative Investments,Aros Capital Partners and Gulfmena Investments. Meanwhile, a former senior investor within the merger arbitrage and credit fund at London-based alternatives manager GLG, Georges Gedeon, and Jean-Luc Biamonti, formerly of Goldman Sachs, have set up a new Paris-based hedge fund, Mereor Investments. Other moves have come from BlackRock, Veritas, the UK firm, and Man Group.   

Some of the hard numbers may explain this flurry of activity. According to the Chicago-based Hedge Fund Research firm, two-thirds of funds experienced inflows, while broad-based improvements in investment performance have taken assets higher. After four consecutive quarters of net pullouts by worried investors, some $1.1 billion of new capital was put to work in these funds in the third quarter of this year as market sentiment improved. The organisation’s HFRI Fund Weighted Composite Index, meanwhile, rose by 6.9 per cent in the third quarter, taking gains for the year so far to 17.1 per cent. Total assets in hedge funds now stand at $1.53 trillion, up from $1.43 trillion at the half-way stage of this year.

After the heavy losses of last year, such figures must be music to wealth professionals’ ears. There are signs that the hard numbers are encouraging more players to enter the fray, replacing some of the casualties of 2008. Hedge fund managers are making a bid for independence as applications to start new investment management firms rise by 40 per cent, says Laven Partners, an investment management consultancy. Laven says it has seen a sharp increase in demand for its services.

“Inflows have certainly picked up this quarter. However, there remains also a huge degree of caution,” Jérôme de Lavenère Lussan, chief executive and founder, Laven Partners, told WealthBriefing.

Due diligence

Any recovery in this sector needs to be accompanied by real commitment from client and bankers alike to the kind of painstaking due diligence checks on funds that is needed to avoid past mistakes, he said.

“There is increased demand for due diligence checks. People are now more mindful of risk. We announced a seminar focusing on risk and due diligence in London in October and it was fully booked within 48 hours of our advertising it," he said.

The focus on risk is undeniable. At Union Bancaire Privée, the Swiss private bank that was hit by losses from Ponzi fraudster Bernard Madoff, the firm recently announced it was strengthening its risk management systems. UBP Asset Management, one of its divisions, has appointed Matt Auriemma as co-head of structural risk analysis.

With this risk-consciousness in mind, a popular route for a hedge fund launch is the UCITSIII fund wrapper. These structures, operating under European Union regulations and which grant managers a maximum redemption notice period of only 14 days, are very much a growing trend. These funds may be limited on the kind of assets they hold and cannot use debt leverage to boost returns, but they have the freedom to take far more positions than is the case with a long-only fund. The old dividing line between "alternative" and "traditional" investing is getting blurred.

Laven’s de Lavenère Lussan notes that one type of fund vehicle being put into UCITS wrappers are commodity trading advisors, or CTAs, which are funds that trade futures and other derivatives systematically, usually assisted by computer-driven models.  


There have been a host of UCITSIII hedge fund-style launches or moves by hedge fund businesses to exploit the freedom that these wrappers provide, such as Bluecrest, Brevan Howard, Marshall Wace and Castlestone Management.

There are other adjustments. Mr de Lavenère Lussan notes that some funds, such as those registered in the Caymans, are being structured differently to align the long-term interest of clients more closely with those of the hedge fund managers. He gives the example of how funds are offering to reinvest performance fees in a fund and only levy it once the investor decides to redeem their money.

But as he stresses, there is no substitute for good due diligence checks on managers and their processes, since it is unwise to rely on the wording of fund documents as fund managers can reserve the right to change the wording if they wish.

Risks and regulations

Yet another scandal has reminded investors of the risks that come not just from market falls, but alleged wrongdoings or system failures. The US government has charged billionaire Galleon Group founder Raj Rajaratnam with insider dealing practices. (He has denied the charges as at the time of writing). Along with fellow alleged suspects, he built a fund that reached $7 billion in assets at one stage only to collapse to $2.6 billion by the end of March.

 The Galleon saga is just yet another reminder that there is still a “fairly large lump of paranoia in the hedge fund industry”, according to John Godden, chief executive and founder of IGS Group, a firm advising investors on hedge funds.

“Clearly, there are some more people coming back in. Much of the money is more institutional – none of which is a surprise. But I am not aware of any real softening of views by investors towards funds. Things remain quite tough and investors are demanding more for less,” Mr Godden told this publication.

“There are a lot of pressures from investors to get value, particularly at the fund-of-fund level,” Mr Godden said.

John Lowry, chairman and co-founder of ML Capital, a firm based in Malta and Geneva providing advisory services, says the UCITSIII wrapper has its advantages but in a recent speech about Latin American hedge funds, he warned that the European Union’s attempts to regulate hedge funds could prove damaging.

“Many Euro-politicians have reacted to the [credit] crunch by proposing punitive conditions on the distribution of funds that are not domiciled within the EU. This is protectionism, effectively, and it has been suggested that funds should have an EU identity to trade there, or at the very least, should hold EU marketing passports.  ML Capital’s research suggests that this would immediately slash demand for Latin American funds in their present form, just when they have so much to offer,” he said in a speech in Miami.

Generally, however, Mr Lowry is positive about developments such as the growing use of UCITSIII wrappers. He said such funds consisting of one or more hedge funds will be able to be marketed to retail as well as professional investors throughout Europe, a market of up to 200 million people.

The future, at least according to some industry practitioners, is likely to lie with more  transparent, liquid vehicles such as UCITS funds, managed accounts, and listed vehicles. Institutional investors – such as private banks, pensions and family offices – will play an increasingly important role in funnelling money into the sector, while private individuals may take a while to rediscover the charms of the sector and some may never return, industry figures say.

The underlying liquidity of hedge fund invesments - a serious issue last year as markets locked up - has improved considerably over the past 12 months, according to a report this week by SEB, the Scandanavian investment firm. It says, for example: "Hedge funds have thus been able to make use of mark-to-market valuations of their holdings instead of employing the `prudence principle' prescribed in accounting rules. This has helped hedge funds achieve good price performance this year."

The omens look far better than a year ago, but the hedge fund industry still has a way to travel before it can ever recover some of its old swagger and a great deal of client scepticism will have to be overcome. But there is plenty of life in this market yet.

Register for WealthBriefing today

Gain access to regular and exclusive research on the global wealth management sector along with the opportunity to attend industry events such as exclusive invites to Breakfast Briefings and Summits in the major wealth management centres and industry leading awards programmes