As hedge funds see greater gains, managers need to pursue greater transparency and more robust risk management infrastructures, according to an annual global study released today by SEI in collaboration with Greenwich Associates.
The report, entitled "Institutional Hedge Fund Investing Comes of Age: A New Perspective on the Road Ahead", indicates a need for hedge fund managers to enhance their risk management infrastructure and risk reporting, and institutionalize transparency policies to attract new capital, satisfy anxious investors, and protect their reputations.
The study also revealed the importance of fund managers clearly articulating how their investment strategies add value to investors' portfolios, which presents an opportunity for managers to differentiate themselves through market-leading client service, reporting, and education.
The study results found that institutional investors' confidence in hedge funds is growing, as more than half (54 percent) of all survey respondents said they plan to increase target allocations over the next 12 months. That confidence is conditional, however, as the demand for increased transparency and risk management were recurring themes throughout this year's study.
In fact, the focus on risk management infrastructure emerged as the second most important hedge fund selection criteria this year, with 75 percent of respondents deeming it "very important." Notably, it was not among the Top 10 selection factors in SEI's report last year. Only clarity of investment philosophy ranked higher than risk management, with 79 percent deeming it "very important" -- emphasizing the growing demand among investors for transparency and understandable investment strategies.
"The study confirms what we have been seeing and hearing from our clients -- that investors are committed to hedge funds, but managers must get and keep investors comfortable with their investment decision," says Phil Masterson, managing director for SEI's Investment Manager Services division. "Managers must differentiate themselves through increased transparency, enhanced risk management, and reporting as well as better overall client service to gain and retain assets post-financial crisis and post-Madoff. We've been making investments in new technologies and enhancing our services to help our clients do just that over the past 18 months and we'll continue to help them stay ahead of the curve."
Transparency is still a concern, as more than two-thirds (70 percent) of those polled pointed to a lack of transparency as their biggest worry, up from 56 percent in 2009. As for the types of information sought, more than three out of four respondents want risk analytics from managers -- a category of information that didn't even appear in the top 10 last year. Liquidity remains top-of-mind as well, as more than half (58 percent) of investors named liquidity risk their biggest worry in hedge fund investing, with more than 40 percent saying they have taken steps to enhance the liquidity of their hedge fund investments.
The report also noted that investors are not relying on regulation to improve hedge fund disclosure, liquidity, or risk management. Nearly one-third (30 percent) of respondents cite "limited regulation" as a primary concern of hedge fund investing.
"The hedge fund managers best equipped to compete prospectively will be those able to clearly articulate their value proposition and source of alpha, as well as demonstrate institutional-quality operations and risk management infrastructure," says Masterson. Phil Albinus is the former editor-in-chief of Advanced Trading. He has nearly two decades of journalism experience and has been covering financial technology and regulation for nine years. Before joining Advanced Trading, he served as editor of Waters, a monthly trade journal ... View Full Bio