Investors Demand Hedge Fund Changes

Date: Tuesday, March 3, 2009
Author: Dan Molinski, Australian Business

US politicians and regulators are clamouring for tougher rules governing hedge funds, but even greater pressure on the industry is coming from certain investors.

Investment boards for retirement systems, university endowments and foundation trusts that invest in hedge funds are telling hedge fund managers to lower their fees, provide more clarity on redemption rules and make other changes.

These traditionally conservative investors have increasingly put money into hedge funds in recent years, but were stung in 2008 when hedge funds on average lost 20 per cent.

The worry of fund managers is that these investors will yank their money if changes aren't made. But while hedge fund managers are likely to cede some minor adjustments, they still see themselves as a valuable investment tool and thus are unlikely to agree to any major, structural changes.

The hedge fund industry, hurt by poor performance and the Bernard Madoff scandal, has shrunk to about $US1.2 trillion ($1.91 trillion) in total assets from a record high of nearly $US2 trillion in early 2008. The figure is likely to dip under the $US1 trillion mark this year.

Amid such heavy losses, some investors are now calling for a major overhaul to how the hedge fund industry operates.

The typical structure of a hedge fund, a limited partnership where investors purchase shares or interests in the funds to earn a rate of return on the invested capital, is a bad deal for investors, they say.

Instead, investors in hedge funds should set up managed accounts with hedge funds, which can offer more liquidity, lower expenses and reduce chances of Madoff-style scams, they add.

"It is now time to rewrite the rules for hedge fund investing," said Martin Gagnon, co-chief executive officer of Innocap Investment Management, a subsidiary of National Bank of Canada that deals in managed accounts.

But while separate accounts might be great for investors, fund managers who prefer to spend their days trading don't want the administrative headache of setting up managed, separate accounts for each of their investors.

Nor do they want to farm out those tasks to third-party firms.

In defence of the hedge fund industry, managers rightly point out that their losses pale in comparison to the broader market.

Some hedge funds, especially those that made well-timed bets that the housing and equities markets would decline, even notched impressive gains last year and into 2009.

Also, there are few other investment options that offer the same potential for big returns, though the latest scandals and blocks on redemptions have dimmed the lustre of hedge funds.

Cynthia Steer, chief of research at pension fund consultant Rogerscasey, said hedge funds will clearly have to increase transparency on redemption rules. And in some cases, she said they will have to reduce fees.

But any concerns about a virtual collapse in the industry are overblown, she said.

"What are hedge funds?" she asked. "They're vehicles that allow you to get someone's expertise in a specific structure, and people are always going to be looking for skilled people. That objective isn't going to change."

Even on the issue of requests for lower fees, hedge funds are likely to put up a fight with investors. The administration of President Barack Obama recently issued a budget proposal for next year that analysts say would cause hedge fund managers' personal taxes to soar, which could make it impossible for some hedge funds to lower fees and stay in business.