AUM Growth Is Hedge Funds' #1 Goal | Chief Investment Officer

With the competition for assets stronger than ever, hedge funds are diverging from traditional models in hopes of expanding their asset bases.

According to consulting firm EY’s 2015 hedge fund and investor survey, investor appetite in alternative products means hedge funds are facing competition from managers who offer exposure to products not traditionally offered by hedge funds, such as private equity, which 56% of investors said they were either currently invested in or planning on investing in.

At the same time, “the level of AUM [assets under management] necessary to thrive is not only higher than what would have been necessary in the past, but the timeline to achieve these critical thresholds is shorter than ever,” according to EY.

Of hedge funds surveyed, 57% named asset growth their number one strategic priority. In particular, mid-level funds managing between $2 billion and $10 billion most aspired to higher AUM, with 70% saying it was their top goal.

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The second highest priority was talent management, which survey respondents said was a necessary component of asset growth.

“In order to continue our growth, we need to retain and continue to hire top talent,” said one North American respondent. “We’re all competing for the top talent so it boils down to: do they join you or do they join them?”

For hedge funds managing less than $10 billion, the top strategies for attracting assets were accessing new investor bases within existing markets and increasing penetration with existing client types and markets through their current strategies and products.

Larger funds, however, were focusing on growing AUM by becoming a “one stop shop” for investor needs. Their top approaches to growth adding new hedge fund strategies and launching new non-traditional products.

In fact, while 54% of hedge funds managing upwards of $10 billion currently identify as multi-product asset managers, 63% surveyed see themselves offering multiple product types in the next three to five years. Just 23% said they plan to stick with the traditional hedge fund offering.

Smaller funds aspired to more diversified offerings, too. About half of $2 billion to $10 billion firms sell only the standard product, but “they realize taking the leap to a multi-product asset manager is the path forward in a maturing industry,” according to EY. Of hedge funds of this size, 49% plan to become a multi-product asset manager within the next three to five years.

Even funds managing less than $2 billion plan to adapt to the changing industry, but their expectations are “more tempered,” with 58% predicting they will offer some non-traditional products in three to five years, and just 19% reaching for multi-product manager status in that time frame.

So far, survey respondents said overwhelmingly that product diversification has helped their funds grow AUM, increase investor satisfaction, and improve their brand. However, these news products have also had a negative impact on operations and personnel, as well as contributing to lower operating margins.

Also affecting margins were management fees, which fell from the traditional 2% to an average of 1.45%. Hedge funds managing more than $10 billion charged the highest fees, but even for those managers the average fee rate was 1.51%.

This, too, was a result of increased competition, according to EY, with managers forced to be more open to negotiating investment terms if they wanted to secure assets. Of managers surveyed, 60% said they have already offered reduced fees for larger mandates.

EY hedge funds Source: EY

“When you think about where money is being managed, it’s like baseball in 1940,” said Ariel Investments CIO John Rogers, Jr. Thursday to a room full of foundation leaders, consultants, and asset managers.

When it comes to hiring portfolio managers, Rogers argued, many foundations and endowments still need a “Jackie Robinson moment”—a reference to the first African American to play in Major League Baseball when he debuted for the Brooklyn Dodgers in 1947.

“We know they exist, we know they’re out there, and we want to be a part of this.”Rogers was speaking at one of several panels at the Council for Foundations’ 2015 Endowments and Financial Services Summit in New York. Thursday, the first day of the two-day event, included sessions on topics ranging from the future of the economy to governance best practices to impact investing.

But a common thread throughout the day’s events was diversity, which was the topic of two of the day’s six panels, including the one Rogers headlined with three other minority asset managers. Rogers even went as far as to compare the state of the asset management industry to a “modern Jim Crow,” citing racial segregation laws in the US.

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Diversity was first brought up in the conference’s opening remarks and Q&A, when an attendee asked John S & James L Knight Foundation CFO Juan Martinez how his foundation grew its number of minority and women portfolio managers.

“I wish I could say there is a magic bullet or magic lever that we pull,” said Martinez. “The reality is we sat with our investment consultants and we said this is something we want to do and here are the criteria… We know they exist, we know they’re out there, and we want to be a part of this.”

Erica Davies, director of external affairs at the Association of Black Foundation Executives, discussed how to solve the lack of diversity in portfolio managers in a panel she moderated featuring the positive example of the Silicon Valley Community Foundation (SVCF).

Some of the largest barriers, she said, are policies and practices that bar diverse candidates from consideration, such as a minimum number of years in the business or level of assets under management. Misperceptions of the riskiness of hiring minority and women managers add to the challenge. Limited access to diverse investing talent manifests through long-term relationships with non-diverse managers and via gate-keeping consultants who don’t make diversity a priority in their manager recommendations.

“We’re trying to make sure our sourcing is inclusive and that any qualified manager can have a crack at the business.”When the SVCF took on the mission of becoming more inclusive in its manager selection, Bert Feuss, senior vice president of investments, said the first thing the foundation did was address diversity goals with its consulting team. The consultants were asked to determine the total number of managers they looked at, how many of those were minority or women, what number of minority and women managers they recommended, and how many minority and women managers were hired.

The results confirmed Feuss’s suspicions: Diversity needed to be prioritized in the manager selection process. From 2013 to 2015, the SVCF increased its number of female and minority managers from three to eight, with assets managed by women and minorities growing from $52 million to $139 million from 2013 to 2014.

“We’re not working toward a specific number or a specific percentage,” Feuss said. “We’re trying to make sure our sourcing is inclusive and that any qualified manager can have a crack at the business.”

Besides discussing diversity goals with consultants, Davies said foundations working to be more inclusive in their own manager selection should develop intentional and explicit diversity policies and connect diversity and inclusion efforts to performance appraisal. Additionally Davies recommended getting to know the diverse talent that’s out there, through minority organizations or conferences.

And why not cast a wider net, asked Thurman White, president and CEO of Progress Investment Management and a board member of the SVCF. “It’s making sure you’re not missing investment opportunities.”

“The talent has always been around,” White said. “What’s lacking is opportunity.”