The Transformation of the Hedge Fund Sector
It is an investment fund that combines capital from a specific number of authorized retail investors or institutional investors and invests in various assets, frequently with intricate portfolio development and risk management practices.
A hedge fund is monitored by a professional company. Hedge funds are usually different from mutual funds since their use of leverage is not capped by controllers, and distinctive from private equity funds as the maximum number of hedge funds invest in comparatively liquid assets.
The word “hedge fund” originated from the corresponding long and short positions that the primary funds used to hedge the market risk. Over a period, the categories and descriptions of the hedging models extended, along with the various kinds of investment vehicles.
At present, hedge funds involve in a varied gamut of markets and strategies. They engage in a comprehensive range of financial instruments and risk management procedures.
Hedge funds can be accessed only by specific accredited investors and cannot be provided to the normal public. Normally, they evade direct controller oversight, avoid licensing needs relevant to investment firms. They function with more resilience than mutual funds and alternative investment funds.
However, post the financial crisis, stringent regulations have been passed in the US and Europe to enhance regulatory oversight of hedge funds and eradicate some regulatory inconsistencies.
Hedge funds are mostly open-ended and permit extensions or removals by their investors (mostly on a monthly or quarterly basis). A hedge fund’s value is measured as a portion of the fund’s net asset value, implying that rises and reductions in the value of the fund’s investment assets are precisely replicated in the quantity an investor could remove in the future.
Several hedge fund investment strategies seek to accomplish a positive return on an investment, irrespective of the market environment (absolute return).
Hedge fund stakeholders frequently invest their personal money in the fund managed by them, thereby aligning their interests with those of the fund’s investors.
A hedge fund normally pays a yearly management fee to the investment manager.
The hedge fund sector has witnessed a paradigm shift in recent times. As hedge fund managers and investors look to overcome new challenges due to regulatory and cost constraints, modified operational concerns and the competition for talent, those constantly innovating and staying in sync with market demand continue to develop.
In other words, efficiency is the key factor. Leveraging technology and ensuring data optimization are the game changer.
Start-ups are penetrating the sector. Several funds are witnessing substantial development in their assets under management (AUM).
Some key challenges that the sector has to overcome:
Accomplishing the performance standard
It is not easy to perform consistently during a long duration of the bull market. Many post-crisis aspects like the sustained low-interest rate scenario, along with regulatory transformations have influenced the hedge fund managers operating and investment methods.
Increasing stakeholders’ requirements
Investor and regulatory requirement for augmented transparency, pressure on fees, and improved alignment of interests have augmented to levels that have not been seen before.
The influence of regulatory modification
The scale of emphasis and transformation post the financial meltdown at a global level have positioned a substantial pressure on individuals, operating structures, and technology competencies.
Impact on operating margins
The operational costs have increased greatly, resulting in more entry barriers for new players, while impacting the economics of even the prominent managers.
Negative Image
If even one manager does not perform in line with the laws, it results in a decrease in the investor confidence.
The idea of a traditional “hedge fund” has been defied. The distortion of functions and concurrence with other sectors within the asset management, and largely, financial services sector, have made it difficult for hedge funds to maintain their brand image and highlight their benefits, visibly in the market.
Brand management is the key as funds flow to the most prominent managers. However, start-up hedge funds are witnessing excellent investor demand. The investor base has transformed radically.
Around ten years ago, two-thirds of the investors were high net worth, while one-third was institutional. At present, the opposite is true.
The manner in which hedge funds are sold has also changed. The influence of digital and social media would only accelerate the change process. The emphasis on the investor and the “client experience” has reached a high point, and is often in conflict with the global regulators.
Growth continues to be the key priority for managers, especially in a lower margin scenario. Smaller and mid-size managers are seeking to increase their client base. The mega managers who have established their presence within the sector look to expand their product offerings.
There has been a change as managers have arranged to offer new plans within the normal hedge fund vehicles, partially due to the varied operational and financial outcomes of introducing new products, but also due to a reflection on modifying investment requirements by market participants who are very tech-savvy, and seek customized exposures that are in sync with their distinct investment objectives.
Managers are being impacted by the latest bank regulations. Several bank regulations, especially those due to Basel III and Dodd-Frank, have increased the constraints faced by managers. Hence, managers have to implement a different strategy.
Moreover, to negate increasing costs, managers are leveraging technology and outsourcing as tools to establish a robust and cost-efficient operating model.
Data management and technological advancements are key to managing progressively complex fund transactions, increasing attention around cyber security along with the growing regulatory and investor-directed reporting needs.
Some of the key priorities of a developing sector
· Disparity in approach to accomplishing growth.
· Investor demand for alternate products continues.
· Product diversification assists managers commercialize.
· Management fees remain under stress.
· Prime brokerage fees increase.
· Centralized treasury is a vital process in managing the complete business.
Hedge fund managers must focus harder on the financial concerns of operating a business. They have to get an insight on the impact of a lower revenue scenario while looking for opportunities to optimize the operating infrastructure. Managers must be aware of the influence of investments, especially in technology in the business.
Several hedge fund managers have ensured their operations and brand acceptance are in sync with international financial institutions. Managers must anticipate the requirements of a varied investor base.
They must comprehend the transforming economic environment. The future of the hedge fund sector is exciting. The tech-savvy managers continue to develop imaginative methods to secure market share and establish businesses that would develop their distinct legacy.
Though more challenges can be expected in the future, the long-term outlook for the sector is positive.
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