The global hedge fund industry is starting to strut again.
A recent Deutsche Bank survey showed that institutional investors were flocking to hedge funds. Deutsche predicted the sector’s assets under management would pass the $3 trillion mark this year.
And 84% of investors in a new Preqin report said 2013 performance — up 11.1%, after a gain of 10.1% in 2012 — had met or exceeded their expectations. This was a nice turnaround from 2011, when hedge funds lost nearly 2%.
Robert Mirsky, global head of hedge funds at KPMG, recently spoke with Hedgeweek about trends he was seeing in the year ahead: hedge fund managers are focused on cost effectiveness, liquid alternatives are gaining prominence and regulation is acting as a catalyst for European hedge fund growth.
Operational Cost Efficiency
Mirsky said he and his KPMG colleagues had continued to see margins being squeezed. Fee compression was coming at a time when the cost of doing business was rising.
He pointed to KPMG’s recent global survey that put the cost of regulatory compliance at 30 to 40 basis points depending on location.
“If 25% of the management fee is being taken up with regulatory compliance, it’s clear to see just how much operating margins are being squeezed,” he said.
Mirsky said managers faced with lower operating revenues were striving to run their businesses more cost-effectively through increased use of new technology, particularly cloud-based technology, and willingness to outsource non-core functions, a trend he expected would continue in 2014.
He contrasted the desire among managers in recent years to spread counterparty risk by using multiple prime brokers with another emerging trend.
“What’s interesting is that now we are seeing managers choosing to use one key service provider to handle a variety of services from prime brokerage to custodial services to fund administration.”
He said many universal banks were well positioned to provide these services, and to do so without increasing counterparty risk because the services tended to be separate legal entities within the holding company with Chinese walls separating their activities.
Indeed, this is now becoming a core part of certain universal banks’ business strategy, Mirsky said. Like the managers, bank institutions that support them also face increased revenue pressures because of capital restrictions under new regulations.
Giving managers access to the whole banking platform is good for both parties, he said. It also has the potential to keep cost to a minimum for the manager because all of the counterparty risk is centralized.
“There are innovative ways of dealing with rising costs,” Mirsky said. “If you aren’t looking to outsource as a smaller manager, you won’t survive.”
The figures explain why. Mirsky put the average break-even size of today’s hedge fund at $150 million, but said a huge number were running with less than $100 million in assets under management.