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Challenges for hedge funds seeking institutional assets

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Until recently, being able to tout impressive performance was basically all a hedge fund needed to thrive.  No longer is that a ready formula for success.  For one thing, delivering stellar returns is easier said than done in this market. Hedge funds also face burgeoning ranks of direct competitors plus a growing challenge from a range of traditional and private equity managers. 

So far most managers appear to be weathering the current environment, but for the first time many will have their investment strategies, management capabilities, operations and leadership team put to the test. Given that many corporate pension plans, foundations and endowments are continuing to assess their comfort level with hedge fund investing, many institutional investors will be scrutinizing their alternative manager resilience in these tough times.

To help hedge fund managers understand the competitive requirements of the institutional landscape, SEI’s Investment Manager Services division, which provides fund outsourcing services to alternative investment managers, partnered with the research firm Infovest21 to analyse industry trends and survey more than 100 institutional investors. Based on SEI’s analysis, hedge fund managers can expect institutional clients to increase pressure on a range of issues, demanding:

  • A strong management team with a full range of skill sets and reasonable continuity. From the institutional perspective, having one or two investment superstars is no substitute for a well-staffed organisation, be it an up-and-coming boutique or a long-established fund with billions under management. 
  • Solid infrastructure incorporating third-party administration and valuation. In fact, the institutions in the SEI survey ranked infrastructure as their number-one criterion in manager selection, reasoning that ‘better managed funds produce better returns’.  
  • A verifiable track record for their current people and products. Many institutional investors say they would favour a fund with a well-documented, three- to five-year history of consistently good results over one with a briefer record of outstanding performance. 
  • A transparent investment strategy and process.  More than 85% of institutions surveyed said they would not invest in a strategy they did not understand. While few wanted portfolio transparency at the position level, more than half said they seek it at the sector or industry level.    
  • Demonstrated adherence to the highest standards for compliance and business practices. With a growing whole new body of regulations and ‘best practices’ guidelines now emerging from working groups in the UK, Europe and the US, the bar is certain to be raised much higher than in the past around these issues.

The pressures for hedge funds to voluntarily adopt and help advance industry best practices can only be expected to intensify going forward, especially if managers cannot offer outstanding performance.  Right now, many hedge fund managers are understandably preoccupied with today’s economic and market challenges as they search for new opportunities and novel variations on formerly winning strategies. But they must not forget to update their competitive mindset at the same time. The industry must recognize that for institutional prospects and clients, performance is only the beginning.

By John Alshefski, Senior Vice President, SEI

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