Hedge funds popularity on the rise: KPMG and CREATE study: Investors tired of high fees

Date: Tuesday, July 6, 2004

Keith Kalawsky-Financial Post- Investment managers around the globe are increasingly adding hedge funds to their product lineups, according to a new study by KPMG LLP and CREATE, a business think-tank. But it's far from clear whether this love affair will last, or whether asset managers are just desperately searching for a short-term sales boost. The reasons for the move to hedge funds are varied: Jilted investors are fed up with expensive management fees for marginal performance and the spate of mutual fund scandals. And there is still huge overcapacity with scores of duplicate mutual funds and products that differ only by name. After taking a beating between 2000 and 2002, the profitability of investment managers improved in the second half of 2003 and into 2004, prompted by stronger equity markets. But few believe this rally sustainable, In June, for example, net assets in the Canadian mutual fund industry increased just 0.5% from June, according to the Investment Funds Institute of Canada. Consequently, many companies are looking for ways to avoid the boom-and-bust cycle that plagues the industry by cutting costs. Some firms are trying to adapt by offering new products, including hedge funds. While most investors are still focused primarily on equities, more than 20% of investment managers said their clients have been attracted to hedge funds in the past two years. About 40% of respondents predicted that customers will be focused on hedge funds in the next two years, along with other alternative products such as private equity and real estate. KPMG polled about 300 investment managers. As one survey respondent said, "Hedge funds are a response to dire performance in the past. The price of being in them is only exceeded by the price of being out of them." "It's like when Nortel was in the TSX Index, you had to be in Nortel. It's herd mentality here," said Harry Ort, head of KPMG's financial services practice in Canada. But the rising popularity of hedge funds among asset managers is paradoxical. Mutual funds are being pushed to improve their governance after numerous misdeeds have come to light, so should they be relying on hedge funds, which are notorious for their lack of transparency and regulatory oversight, to fuel sales? The future of hedge funds may depend on resolving this conundrum. "It will really come down to how the industry reforms itself to deal with its critics," Mr. Ort said. The rush towards hedge funds is also being driven by the desire to improve performance, which some firms see as the only way to regain the confidence of investors. "Clients are wising up now," said one respondent. "The losses in the bear market have totally altered client perceptions." In turn, some large asset managers are trying to structure themselves as a "village of boutiques," the study notes, where portfolio managers are able to focus on specific sectors and products, and generate original investment ideas instead of following the herd. Portfolio managers, research analysts and product specialists work in these small units of about seven people, and share back-office services with other boutique units within the same firm. In other words, larger investment managers are trying to duplicate the structure and performance of boutique shops. It also puts more emphasis on portfolio management teams instead of so-called star managers. Three in five managers are adopting this boutique structure, the study reports. By doing this, fund companies can also acquire and easily integrate boutique firms, including hedge fund managers