By Peter Douglas of GFIA, with an introduction by Simon Kerr
When Richard Hills wrote “Hedge Funds: An Introduction to Skill-based Investment Strategies” in 1996 the hedge fund industry consisted of relatively few firms dominated by the idiosyncratic talents of their seasoned leaders. The landscape today is very different – many of the investment strategies implemented by the managers of 1996 have been turned into ETFs or replicated quantitatively.
The vast majority of the assets of the hedge fund industry are managed by very large firms of two types – brand name firms with a team for each of the strategies undertaken, or managers specialising in one strategy utilising a large staff with sub-teams for each component of the process (think of primary research, secondary research, risk management, data procurement etcetera).
That institutionalisation has raised the bar in some areas is undeniable. But one of the costs has been a decline in entrepreneurialism in the hedge fund industry. Peter Douglas suggests this commercial appetite might emerge in a different form…and elsewhere.
If a Singaporean consumer tries to interact with a Singaporean insurance company to buy a Singapore insurance product denominated in Singapore dollars… from this year now has to complete a form warranting that she is not a US person, for FATCA compliance. That’s at the retail level; at the professional level of a hedge fund, the globalisation of regulation has been a reality for many years now.
A manager in Hong Kong wanting to reach European investors is likely to need a European fund structure in order to attract any kind of distribution, accepting that the constraints of the structure will constrain their investment parameters relative to their offshore fund. A colleague of mine recently hosted a panel discussion at a conference, discussing the tensions between the almost surreal levels of contemporary “due diligence”, and the resulting impact on performance. The private investors, a dwindling influence on the hedge fund industry, lamented that managers were increasingly building organisations designed to pass complex due diligence processes rather than to produce maximum performance. However the institutional investment community was adamant that an “institutionalised” structure was worth some cost in terms of performance foregone.
Regular readers will, for many years, have sensed our disillusionment with “Macfunds” – large, relatively homogenous, process-driven, hedge funds run by commensurately large organisations, often with ownership removed from the practitioners managing the money. GFIA’s premise, that a hedge fund, by definition a structure allowing an experienced and skilled investment professional to deliver that skill to investors with the minimum interface needed, is increasingly irrelevant in the context of the homogenisation of the industry. However, the structural environment today militates against truly skill-based investing. We believe that the day of the hedge fund as we know it, is over.
We see a rapid growth in “shadow” finance. Despite its murky connotations, this is the healthiest area of the investing arena. As the gini coefficient of the developed world continues to expand wealth, the supply of privately controlled assets looking for the best investment brains, is arguably getting stronger. But this wealth is increasingly bypassing the “fund management industry” in favour of investing directly, of hiring good people directly into the asset-owning organisation and other routes to bypass the system. We see a growing number of talented managers in effect retiring from conventional fund management in favour of managing capital privately.
The convergence of global (and often politically, not pragmatically, driven) regulation, and the dominance of performance-insensitive but headline-risk-supersensitive institutional capital, has created a powerful industry of large asset-gathering alternative asset management companies, and conversely is slowly squeezing out skill-based fund management.
It’s sometimes hard to see a future for the hedge fund industry. Nevertheless, the heartening growth of under-the-radar, unregulated businesses bodes well for the longer term future of some sort of skill-based asset investing industry: it just won’t be a hedge fund industry.