Uncertainty, volatility to drive hedge fund success

Hedge funds professionals may be overly optimistic about the future of the industry, but prevailing market conditions will ensure the funds’ future success, delegates at the GAIM Ops conference at the Ritz-Carlton, Grand Cayman, heard Tuesday. 

John Fraser, chairman and partner at UBS Global Asset Management, said there seems to be “a bifurcation between the global economy and the massive, singular confidence of hedge funds.”  

“It may be that our confidence about the hedge fund industry is misplaced,” he said, speaking at the event, which focuses on operational due diligence, risk management and compliance in the alternative investment industry. 

However, he believes the hedge fund industry will prosper because of the uncertainty and volatility in the global economy which will play into the hands of hedge funds. 

The uncertainty will persist because the macroeconomic policy response to the crisis has essentially not worked, managing only to alleviate symptoms. “After six years, we are still not seeing sustained growth in many of the major economies,” he said.  

The real challenge will be the move from managing money in a quantitative easing era into a “post-QE era.” Yet, investors have been lulled into complacency by the equity market performance. 

“I have a horrible feeling we are riding a wave and it will be interesting to see [what happens] when that wave finally breaks on the shore,” Mr. Fraser said. 

Geopolitical risks in the Middle East and fears of Russia’s territorial expansion in Europe add another layer of uncertainty for investors. It was therefore no surprise that investors’ risk appetite remains extremely low.  

At the same time, companies that are carrying significant cash balances are more concerned about returning these funds to investors through dividends and share buy-backs than they are with investing into their own businesses. 

The level of cash holdings by individuals has risen to nearly 30 percent, an all-time high, Mr. Fraser noted. 

But there is also good news for the asset management industry. Global savings requirements are increasing, and pension savings for retirement and healthcare will only continue to grow, as people live longer. The challenge for the industry will be to not squander this opportunity, he said. 

Hedge funds have been helped by their more recent performance. The performance “hiccup” after the global financial crisis was mainly due to “marketing hype” and the industry overselling what it could do. “There was too much thinking we could ride through any storm without getting too wet,” Mr. Fraser said. 

The hedge fund industry will also need to be careful about capacity, by managers not taking in too much money so that their funds’ agility is restrained.  

The challenge for funds of hedge funds will be to move more into the active management of a portfolio of hedge funds to justify the second layer of fees. A greater distinction in the funds of funds market is also needed between those investors who want liquidity and those “who don’t have to pay for liquidity they don’t really need,” he added. 

Much of the fee pressure experienced by the asset management industry, he said, has been caused by the increasing in-house management at pension and sovereign funds. With the growing sophistication comes greater buying power. 

“Hedge fund remuneration is high, probably too high from a social point of view. But one legitimate justification is that it is predominantly linked to performance fees,” Mr. Fraser said, adding that in his experience, sophisticated investors are willing to pay the fees if there is performance.  

“And the performance fee structure is a real plus for hedge funds,” he said.