Summary
Hedge funds lost more than $700 billion in second half of 2008, and 2009 might be even worse given the current outlook for the financial and economic environment. Hedge funds need a survival strategy and more metrics need to be shared on both sides of the conversation between the hedge fund and institutional client. Those hedge funds that survive need to offer, among other things; repeatable performance, fair fees, top-notch client service, robust risk management, transparency, sound operational infrastructure, and a safety guarantee for custody of and institutions assets.
Analysis
The first generation of hedge funds was all about absolute return, with a high-net worth client base, and little regard for risk management or processes therein. The second generation, which emerged in-and-about 2000, caused hedge funds to get much more process-oriented as institutional investors began moving into alternative investments (hedge funds). The hedge fund community will likely be careful as to not offend this institutional client base going forward as that which occurred in 2008 where many funds instituted redemption gates and liquidity lock-ups.
According to a recently released report published by Deutsche Bank, hedge fund investors are expected to redeploy up to $82 billion back into the marketplace from cash over the course of 2009. It is likely safe to assume that the majority of this cash infusion (if indeed it occurs) will be allocated to the larger and/or largest of hedge funds available across the community (this is especially true for pension funds and other institutional investors).
As the aforementioned report also points out, just as 2008 was a story about performance, 2009 will be a story about restructuring throughout the hedge fund industry. Growing concerns about risk management and transparency are leading institutional investors to allocate more money to larger hedge fund managers at the expense of start-ups. The consolidation within the industry will likely continue, because only the larger players have the required level of infrastructure.
Performance is king, but as is the case with “old-fashioned” traditional money managers; when hedge funds have strong relationships, good client service can more often than not buy them enough time to turn poor results around and restore client investment confidence. Numerous studies and surveys have shown that with top-notch client service, outflows are smaller and slower, and overall client retention is higher.
