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Asset flows moving from long-only equities to hedge funds, says Tabb study

Date: Thursday, September 20, 2007
Author: Hedgeweek.com

Assets invested in 120/20 and 130/30 active-extension funds are set grow at a compound annual rate of 141 per cent, from USD140bn this year to nearly USD2trn by 2010, according to a new report by the Tabb Group.

By contrast, actively-managed US equity mutual funds, the largest segment of the mutual fund industry in terms of assets under management, will grow by just 3 per cent over the same period, the group predicts in the study, entitled Alternative Investments 2007: The Quest for Alpha.

The survey also finds that 40 per cent of fund managers believe trading costs are the most significant cause of lost alpha, while only 35 per cent of managers believe brokers help them capture alpha. However, size and satisfaction are linked as larger management firms are overwhelmingly more satisfied by their brokers' ability to help them capture alpha.

'A major change is underway at alpha-seeking firms,' says Larry Tabb, founder and chief executive of the eponymous firm and co-author of the study with Jerome Johnson. 'They are becoming more creative, moving overseas and towards frontier markets, moving up and down the capital structure, moving toward shorter-term, event-driven strategies and longer-term holding strategies that resemble private equity-type investments.

'Also, shorting and leverage, used by the first hedge fund as early as 1949, are becoming more sophisticated and mainstream, proven by the explosion in assets under management in enhanced active, enhanced long and short extension equity strategies.'

Ninety per cent of the fund managers interviewed believe that the growth of active-extension funds will increase as the pressure for increased yield and increased fees push traditional managers into this new area.

However, this shift in asset flows cannot happen by itself. Says Tabb: 'It must be driven by the clients of today's asset-management companies, from pension plans, trusts and foundations to corporations and high net worth individuals. It also includes massive mutual funds that cater to the mass-market retail investor. As these firms reposition themselves, expanding and transforming to cater to their clients, other changes must happen as well.'

The report says new products and strategies such as absolute return, portable alpha, and multi-alpha funds will affect the investment value chain. As managers seek to become more global, they must expand asset selection strategies and become more nimble about moving in, out and between different risk and capital structures. This will affect how firms are serviced and brokered, technology infrastructure is implemented and operations are structured, all in pursuit of alpha.

'This will also affect investors, because track records do not yet exist and these complex strategies have few services to vet them or ensure their fidelity,' Tabb says. 'But with opportunities come adventures and as long as the oyster doesn't close on a finger, the quest to find the pearl can be exhilarating, the rewards enormous.'

Tabb Group interviewed 67 portfolio managers, chief investment officers, heads of research and senior managers of hedge funds, funds of funds and traditional long-only asset managers, with a particular focus on traditional equity managers who have launched active-extension funds.

Collectively the respondents manage USD12.3trn in assets, with more than 90 per cent of those assets managed by large fund companies (defined as managing assets of more than USD50bn for traditional managers and USD2bn for hedge funds).

Other findings from the report include the belief by almost half of the fund managers surveyed that new geographic markets will generate their greatest source of new alpha.

The study predicts that research with continues its transition from a sell-side function to one performed by the buy side. By 2012, the buy side will generate 63 per cent of its research internally, the study says, with spending on broker research declining to USD3.42bn.

More than half of the fund managers surveyed say they will increase their spending with independent research providers, whose revenues are expected to grow from USD1bn in 2002 to USD2.4bn in 2012, a compound annual growth rate of 9.15 per cent.

Tabb Group is a research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on an interview-based research methodology developed by Larry Tabb, the firm analyses and quantifies the investing value chain from the fiduciary, investment manager, broker, exchange and custodian.