That’s the message from assurance, tax and consulting firm McGladrey’s latest hedge fund industry report, released this month (click here to download the full report for free; a short questionnaire is required). The report, a survey done in conjunction with Greenwich Associates, makes plain that when it comes to attracting institutional assets, most mid-sized hedge funds simply don’t have the infrastructure and personnel to truly service those kinds of allocations.
Indeed, while the majority of hedge funds surveyed for the report said they’re confident they have the girth to bring in and keep institutional assets, only a fraction of those have more than one full-time employee that handles client services. Even fewer than that have an automated reporting system that can satisfy what institutional investors require (see bar graph below showing managers’ readiness to meet investors’ demands).
Worse, the report found more than 90% of the 52 U.S. hedge funds surveyed appear to have an unfocused business model – a throw-it-at-the-wall-and-see-if-it-sticks approach to targeting all investors, be they institutional, funds of hedge funds (FoHF) or high net worth/family offices. The report defined a mid-sized hedge fund as having assets of between $100 million and $500 million.
The findings aren’t much of a surprise given the rush among hedge funds to attract and retain “sticky” institutional money that, in their view, won’t fly out the door the next time a black swan appears on the horizon (click here for AllAboutAlpha.com’s recent coverage of the hunt for “sticky” assets). They’re also in line with a longer-term issue that mid-sized hedge funds have been grappling with long before the financial crisis ever hit: whether to put the chicken in front of the egg and invest in infrastructure that will meet and hopefully exceed institutional expectations or try to lure the money in the door first with the promise of bolstering infrastructure one the check has cleared. The chart below shows that more than half of managers surveyed indicated no change in client reporting requirements post 2008.
Of course, the goal posts have moved significantly since the Great Market Meltdown and rush for liquidity reduced total hedge fund industry assets by more than a third. Institutions are much more focused on keeping eyes and ears trained on their managers. Ernst & Young’s recent hedge fund poll (click here to read AllAboutAlpha’s synopsis) noted that performance information (38%), risk information (25%) and transparency of holdings (25%) were the three factors institutions were most focused on when it comes to hedge fund allocations.
To assess risk, investors said they consider leverage (66%), largest holdings (55%) and asset classes (53%). Managers, on the other hand, felt the most important risk information included asset classes (81%), industry sector (75%) and geography (75%). The E&Y survey didn’t even address infrastructure and hedge funds’ ability to provide informational requirements that institutional investors now demand.
To be sure, mid-sized hedge funds have made some progress on the institutional money-grabbing front: Nearly one quarter of respondents (23%) said they have seen an increase in institutional clients over the past two years. While 17% reported a decrease, which is still a net gain, divergent responses from those polled highlight the significance of having an institutional-friendly infrastructure.
Indeed, nearly half of the funds surveyed that claimed institutional investors accounted for the majority of their clients said having a dedicated client service team was “critically important” in winning assignments. On average, funds with two or more full-time sales professionals won more than 10 mandates in the past year; funds with fewer salespeople won 7.
The divergence in opinions didn’t stop there, particularly on the “we are prepared” front: A little more than a third (37%) of mid-sized hedge funds said they now have more onerous reporting requirements regarding performance and risk, while a full 85% said they believed their current infrastructure was sufficiently capable of handling client reporting needs for the next five years. The graph below illustrates the various types of additional information hedge funds said they are being asked for.
Meanwhile, 26% reported having either “manual” or “highly manual” reporting systems, meaning they aren’t entirely prepared to pass over the information that institutional investors demand in terms of positions, valuations, liquidity, leverage and other references.
In short, nothing new – other than the fact that pre-2008 it was hedge funds that were holding the bag as institutions clamored to get in the door before anyone else did. With the shoe clearly now on the other foot, it remains to be seen whether mid-sized hedge funds can continue to adapt to investors’ needs.