Institutional Investor's Alpha Magazine - April 2008 - (Page 84)

Unhedged Commentary By Paul Schaeffer No Time for Complacency mid all the turmoil rocking the world’s ﬁnancial markets, the hedge fund industry continues to ﬂourish. Assets under management grew by 27 percent in 2007 and 32 percent the year before that. Although the creation of new hedge funds has slowed somewhat since its peak in 2005, the industry now stands at more than 10,000 funds, with total assets under management fast approaching $2 trillion. And although researchers forecast challenges for traditional investment managers, especially those that specialize in U.S. equities, they are still spotlighting alternatives like hedge funds as the primary focus for consultants advising institutions. Yet when hedge fund managers look at other numbers, they might not be quite so sanguine. Nearly six out of every ten hedge funds have existed for ﬁve years or less; one third of funds have been around for no more than three years. So for many hedge funds, this is the ﬁrst time that their investment strategies, management capabilities, opThe ongoing market erations and leadership teams will be turbulence is likely put to the test — and pension plans, foundations and other institutional to make institutional investors will be scrutinizing the results closely. investors even Hedge funds must recognize more demanding that institutional investors are different from their industry’s tradiof their hedge tional high-net-worth clientele. An SEI Investments Co.– sponsored fund managers. survey of more than 100 institutions last year found that they are a demanding lot with distinct expectations and objectives. Even stellar investment performance isn’t enough to impress them. They care as much or more about diversiﬁcation, risk-adjusted returns and investing in strategies they can understand. Headline risk is the thing that keeps these investors up at night. Not surprisingly, many institutions prefer to invest with hedge funds that look and act much like institutions themselves, especially during times of great stress. I’m not suggesting that seesawing stock indexes, a weakened dollar and rising oil prices will cause institutions to ﬂee hedge funds en masse. To clients looking hard for alpha, wellmanaged, noncorrelated and opportunistic strategies will undoubtedly retain appeal. The key term here is “well-managed.” As volatility spikes and portfolio returns soften, money managers are A wise to assume that whatever has made institutional investors nervous in the past will make them even more skittish now. In this difﬁcult investment climate, large investors may be even less inclined to give the beneﬁt of the doubt to hedge funds with murky strategies, vacant management positions or less-than-ideal valuation methods. This is no time for hedge funds to be complacent. With institutions in the pilot’s seat, driving asset ﬂows, managers should prepare themselves for a potentially bumpy ride. Based on responses to the SEI survey, hedge funds can expect institutional clients to turn up the heat on a range of issues, demanding several things: Institutional-quality infrastructure. Nearly half of investors named this as their No. 1 criterion when selecting a hedge fund. Sound administrative and valuation methods. Among investors most concerned with infrastructure, two thirds said it is unacceptable for funds to handle administration internally. More than 80 percent said they take steps to verify that hedge fund investments are valued independently. Clearer, more-comprehensible strategies. Eighty-ﬁve percent of respondents said they would not invest in an investment strategy they didn’t understand. Greater transparency. More than half the investors said they want visibility at the port folio, industry or sector level, and one third were most concerned with the transparency of the investment process. Stable management teams. Institutions look for hedge funds that have filled key management and support positions and established clear divisions of labor among team members. So far most hedge funds appear to be weathering the recent storm. But the pressures on managers to voluntarily adopt and help advance best practices will only intensify. At this point the hedge fund industry has no shortage of guidelines and models from which to choose. The U.K.’s Financial Services Authority and the President’s Working Group on Financial Markets and the Managed Funds Association in the U.S. have all put forward versions of commonsense policies and practices. Managers who are paying attention will know what to do. Paul Schaeffer is managing director of strategy and innovation for Oaks, Pennsylvania–based SEI Investments Co.’s investment manager services division, which provides administration and other fund services for investment managers. 84 • INSTITUTIONAL INVESTOR’S ALPHA • APRIL 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - April 2008

Institutional Investor's Alpha Magazine - April 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Here to Eternity The Good Guys: Voice of Hope Cover Story: The Kings of Cash Where the Money Is Into the Light Interview: Proceeding with Caution Strategies: A Convenient Truth Alpha Bytes: Village Voice Unhedged: Commentary: No Time for Complacency

Institutional Investor's Alpha Magazine - April 2008

For optimal viewing of this digital publication, please enable JavaScript and then refresh the page. If you would like to try to load the digital publication without using Flash Player detection, please click here.