Institutionalisation of investors prompts greater risk management and fee concessions

Feb 11, 2011 by Martin Leonard

The institutionalisation of hedge fund investors is having a significant impact on the industry with managers enhancing their risk systems and reducing fees, according to a survey by research specialist Preqin.

Approximately 61% of hedge fund capital now comes from these sophisticated investors. This has prompted nearly half of the 60 managers surveyed to implement tougher risk management procedures in their operations.

“Following fund failures and well-publicised fraud cases, investors have become more aware of the potential risks of investing in hedge funds and have become increasingly demanding of their fund managers to put extra protection in place,” said the report.

There has also been a shift from the traditional 2 and 20/1 and 10 management and performance fee model with 42% of managers acknowledging they had reduced the amount they charge investors.

Hedge fund managers overwhelmingly predict that capital inflows from institutional investors will have an elevated importance over the next 12 to 18 months “with nearly 85% of all fund managers surveyed stating that they expect the proportion of their assets coming from institutional investors to increase over this time frame.”

The report added that if these inflows live up to managers’ expectations over the next two years, this will be the “greatest rate of institutional growth in the asset class to date.” Ken Heinz, director of Hedge Fund Research, recently said he anticipated the hedge fund industry to break its 2008 asset peak of $1.93 trillion over the coming year.

However, smaller hedge funds are at a slight disadvantage when it comes to attracting capital. Some 70% of managers struggled to raise capital because some investors will not invest in funds with less than $320 million in assets under management (AUM).

The report highlighted that many sophisticated investors tend to prefer the largest funds – those with more than $10 billion AUM – due to the institutional-quality infrastructure they have in place. Furthermore, “many institutional investors look to seek safety in numbers by allocating only to the largest hedge funds.”

“The consensus is clear: hedge fund managers are witnessing large inflows of capital from institutional investors, and are adapting their fund strategies and marketing accordingly. Smaller funds continue to find it more difficult to attract institutional investors as many do not have sufficient assets under management to be a viable investment option,” said Amy Bensted, manager of hedge fund data at Preqin.

She added: “However, most fund managers are expecting more money from institutional coffers over 2011 and into 2012 suggesting that the proportion of institutional capital in the sector is due to grow even more over the next 18 months.”


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