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November 05, 2012 at 08:41 AM
Few investors see the benefits of increasing regulatory requirements for hedge funds, according to a new study.
Only 10% of institutional investors surveyed felt that the new regulations would protect their interests, and 85% rejected the notion that these would prevent the next financial crisis, according to Ernst & Young’s sixth annual survey of the global hedge fund market.
The survey, which was compiled by Greenwich Associates for Ernst & Young, compared opinions from 100 hedge fund managers with more than $710 billion under management and 50 institutional investors with some $190 billion allocated to hedge funds on current topics related to the hedge fund sector.
The findings showed that although the two groups agreed on increasing investments in headcount, technology and risk management, stark contrasts existed on compensation structure, fees and expenses.
“Our survey findings suggest that hedge fund regulations are not beneficial to investors, who overwhelmingly question their purpose and proliferation,” Ratan Engineer, global leader of Ernst & Young’s asset management practice, said in a statement.
“It may still be worthwhile for hedge fund managers to constructively engage with regulators to help them stay focused on the main goal—financial stability—rather than introducing more costly or unnecessary requirements that investors feel are of little value.”
The survey uncovered areas of agreement between managers and investors, as well as sharp differences.
Implications of Regulatory Compliance
The survey found that managers were already seeing regulations increasing their costs for upgrades of compliance functions (34%) and technology dedicated to reporting (17%).
For their part, investors expected the additional compliance costs, yet they feared these expenses would be passed on to the funds.
“The general increase in costs, including regulatory-related expenses, has created barriers to entry and has resulted in the consolidation of funds that do not have the capital to support the costly infrastructure required,” Arthur Tully, co-leader of Ernst & Young’s global hedge funds practice, said in the statement. “This is a trend we will likely see continue in the near future.”
Compensation: Unreconciled Differences
The gap between managers and investors on how compensation should align with risk and performance has shown no sign of narrowing since 2010, the survey found.
Ninety-four percent of managers surveyed in 2010 felt risk and performance were effectively aligned with investor objectives, while 50% of investors felt that way. In 2012, 87% of managers felt this was true, while only 42% of investors agreed.
In addition, more than two-thirds of managers said their compensation structure had not changed in the past three years. Just 14% said less was paid in cash, and 10% said compensation was subject to longer deferral periods.
Investors, by contrast, said less than 40% of compensation should be paid in cash. Instead, they preferred to see a larger portion paid in equity and deferred cash, subject to clawbacks. This dissonance has not caused material redemptions, the 2012 survey found, nor did investors cite it as a key consideration for choosing a fund.
