Survey: No End in Sight for Industry Growth

Could hedge fund industry assets reach $3 trillion by the end of this year after cracking $2 trillion only two years ago?

Three out of 10 industry professionals bet they will, according to Hedge Fund Alert’s annual outlook survey. Of the 68 managers, investors, bankers and service providers who participated, 20 predict the total amount of money managed in hedge funds worldwide will increase to at least $3 trillion by yearend — a 20%-plus increase from Hedge Fund Research’s latest estimate of $2.5 trillion. The average forecast for all respondents: $2.84 trillion for an annual growth rate of 13%.

Only six respondents expect assets to remain flat or to dip slightly. At the upper end, Jennifer Dickinson of compliance consultant Sansome Strategies predicted the sector would grow to a whopping $4 trillion (see sampling of forecasts on Page 5).

The bullish outlook assumes a continuation of the robust growth that the industry has experienced since 2009, a year after the financial meltdown caused assets under management to fall sharply to $1.4 trillion.

The big question is whether investment gains can continue to sustain the growth, as they have for the past two years. In the third quarter, for example, gains on invested capital accounted for more than $70 billion of the $94 billion increase in global hedge fund assets, according to the latest data from Hedge Fund Research. Inflows of fresh capital amounted to just $23 billion.

Another question on the minds of many is whether the industry is in jeopardy of growing too large — to the point where managers, even the smartest ones, get crowded out of once-profitable trades and lose their edge. Indeed, some survey respondents believe there already are too many dollars chasing too few opportunities.

“Fundamental investing is getting arbitraged out and the movement is towards algorithm, quant and big-data strategies,” said Tim Harrington, who runs a series of quantitative-investing competitions for emerging managers under the BattleFin banner. “Managers need to adapt and come at things from different angles rather than continue down the same track. Six percent returns in a [stock] market up 30% does not justify 2%/20% fees.”

Lionel Erdely, who oversees hedge fund investments at Investcorp, said overcrowding could be a problem for certain strategies. But managers that invest in “liquid assets such as large-cap equities, sovereign bonds and developed-market currencies will not be impacted by inflows. The total size for these markets is in the tens of trillions of dollars, whereas the total capital deployed by hedge funds is a very small percentage of the total.”

Other industry professionals said talented managers have proven time and again that they can sniff out profitable investments regardless of the competition. “The unconstrained nature of hedge fund strategies allows managers to evolve over time and seek new opportunities,” said Jeff Chan, a vice president at fund-of-funds manager EnTrust Capital. “For example, given the successful track record of the activist strategies, activist managers are able to invest in larger companies today, where such companies were not realistic investments in the past. When evaluating managers, investors should pay attention to the scalability of their strategies over time.”

Anthony Scaramucci, founder of SkyBridge Capital and host of the popular SALT conference series, said once-reliable trading strategies are under pressure not so much from overcrowding, but from a tectonic shift in market fundamentals. “The world changed after the 2008 debacle,” he said. “There are major macro-interventionary forces, where central banks made the decision to go into markets, distorting price discovery. The traditional playbook, which was successful for 30-40 years, is not successful now.”

If designing and executing investment strategies has become more complicated, so too has the business of running a hedge fund operation, the survey found. On the operations side, compliance and risk management clearly are the biggest headaches for most managers. But the challenges are manifold — all the more so for new and emerging managers.

“We believe the biggest operational challenge is matching your infrastructure to the always-fluctuating assets of the business,” said Zvi Rhine, founder of startup Sabra Capital.

At the same time, Sydney McConathy, a vice president at fund marketer Beacon Hill Financial, said hedge fund operators face increasing competition from more-regulated fund structures. “The biggest operational challenge facing general partnerships is how to deal with the flux of new capital investing in ’40 Act and UCITS strategies with far greater liquidity, transparency and lower fees,” he said. “The last stat I heard was that the AUM of ’40 Act hedge funds alone is estimated to be $2 trillion by 2020,” McConathy added, referring to vehicles that follow hedge fund strategies but are registered under the Investment Company Act of 1940.

Ellen Schubert, a senior advisor in Deloitte’s hedge fund-consulting practice, cited the double-edged sword of technology. “Data is the hottest topic by far,” she said. “Every meeting I go into right now is about data — the amount of data that hedge funds have to retain, manage, manipulate and massage for their portfolio managers, their investors, their regulators and the entire company.”

The survey also sought to identify the industry’s leading trend-setters, whether they be fund operators, investors or service providers. Among managers, Dan Loeb’s Third Point was the most frequently cited, followed by Bridgewater Associates, Pershing Square Capital, Two Sigma Investments and Winton Capital. Other respondents pointed to Bloomberg, pension consultant Albourne, the Ontario Teachers pension plan and Neuberger Berman’s Dyal Capital, which buys stakes in blue-chip hedge fund firms.

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