HF Managers Cautioned to Avoid Herd Mentality

Managers are intent on launching new products as growth slows, consulting firm EY says, but shouldn't rely on past performance alone.

Hedge funds managers are turning to targeted products due to increased competition for assets and decreased investor appetite, according to Ernst & Young’s consultancy firm EY. 

Its recent survey found a gradual slowing of allocation to traditional hedge funds. Of 65 institutional investors surveyed, only 13% said they plan to increase their allocations in the next three years, compared to 20% in 2012. About three-quarters of respondents said they would maintain their current allocations.

These challenging conditions have pushed hedge fund managers to pursue new products “trying to offer investors more flexibility on fees and tailored offerings,” said Michael Serota, co-leader of EY’s global hedge fund services. 

The consulting firm also surveyed 100 hedge funds representing nearly $1 trillion in assets and found 32% of managers said their top priority was launching new product types. 

Large managers with more than $10 billion under management identified registered funds such as Undertakings for the Collective Investment of Transferable Securities (or UCITS) as the number one product to launch in three to five years. Other products included separately managed accounts, long-only funds, and insurance-related products.

However, EY warned these new products could cost funds more than expected due to various fee concessions and expensive reporting requirements.

“Without scalable operations, managers are likely to take a hit on margins when they launch new products,” said Fiona Carpenter of EY’s global hedge fund services.

The survey also revealed managers and investors have become more understanding of fees and fund expenses. Only 27% of asset owners said they were dissatisfied with the expense ratio of hedge funds. This figure was higher for pensions and endowments, with 33% expressing discontent.

“Investors’ acceptance of expense ratios is based on their awareness of the increasing cost of regulatory compliance as managers become more transparent,” the report said. “It is incumbent upon managers to work closely with investors that are unhappy about fees, explaining the reasons for the funds’ cost base.”

The consultancy added that at a time of increased competition, managers should be wary of herd mentality especially when considering launching a new product.

Instead, George Saffayeh, Asia-Pacific leader of EY’s global hedge fund services, argued managers should focus on giving investors confidence in “their ability to generate future returns at appropriate risk levels rather than peddling past performance.”

EY hedge fund survey(Source: EY)

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By Sage Um