A bit of a Blur: The Line between Hedge Funds and Asset Management

Date: Thursday, November 1, 2012
Author: Nigel Someck, ProHedge.co.uk

As the line between hedge funds and asset management turns into a grey area, PROHEDGE explores the next great challenge for the hedge fund industry.

Recent industry commentary and opinion has focused to a great extent on the regulation of the Hedge Fund industry through directives such as Dodd-Frank in US and AIFMD in Europe. The sub-plot developing in the background is that hedge funds are going through an identity crisis.

Some believe that the convergence of these two industries is inevitable, particularly once AIFMD revolutionises the European hedge fund landscape.  “The convergence of long-only and alternative investments is happening and likely to continue.” comments Mark Parsonson of Liongate Capital Management.

AIFMD has perhaps been cast rather unfairly as the final nail in independent hedge fund coffin, however, the truth is that the line has been blurring for a while now. Ucits funds were a real revelation, investors and fund managers alike adopted the fund wrapper to such a degree that they now boast an AUM of €5.92 trillion and a reported 75% of the entire European fund management industry. After all, it was Ucits which first allowed hedge funds to be sold to retail investors, a market dominated by institutional asset managers. “I would argue that the implementation of Ucits III has been the main driver of convergence,” said Parsonson. “Greater breadth of investment opportunities and risk management policies have allowed many hedge fund strategies to convert to Ucits III structures and gain broader distribution and access. This trend is well established and continuing.”

Drilling deeper into the trends and changes in the industry, it would be short-sited to point the finger solely at regulations and directives for the convergence. Investors have played their part as well. Today, institutional investors account for 65% of the hedge fund investor community, up from 44% in 2008 (source: Preqin). Institutional Investors such as pension funds, endowment plans and sovereign wealth funds are generally more risk averse than high net worth individuals and they are more experienced investing in the long only world. This explains why hedge funds have been so willing to adopt directives such as Ucits to attract institutional investment and fit into their investment mandates and due diligence processes.

It takes two to tango and whilst the hedge fund industry is drifting towards the asset management industry, there is also momentum from asset management firms moving into the alternatives space. Parsonson trumpets this view “The crisis of 2008 has led to a lot of change within the asset management industry and much of this has been driven internally through evolution of investment practice.” Diversification in investment mandates has forced asset managers to launch alternatives funds, derivative overlays and direct investments in hedge fund managers.

There is no doubt that the line has been blurred into a grey fuzzy area, however it may just stop short of full convergence and hedge funds can retain their independence and unique investment approach. “Ultimately, ‘convergence’ needs to be put into context. A large part of hedge fund strategy returns are generated through their ability to exploit opportunities that traditional investment strategies cannot. Often, many of these benefits are reduced when trying to implement a more constrained and regulated version of an offshore hedge fund strategy. Investors need to be aware of the trade-offs they are seeing in ‘convergence’ products. Greater liquidity and regulation are better for investor protection, but these can also lead to lower return expectations or higher volatility.”

Once the dust has settle on AIFMD, the most nimble funds will find a way to play safe within the regulatory boundaries whilst providing investors greater risk/reward possibilities and diversification at the same time. The industry success stories of the future will be about those hedge funds that buck the convergence trend, adapt to a changing regulatory and investor environment, retain their diversity and provide a genuine alternative investment to asset management firms.

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