Asset AllocationNovember 12, 2013

Costs Outpace Revenues for a Third of Hedge Funds

<em>Margins are shrinking on hedge fund products, but the costs are moving the other way for most, research has found.</em>

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(November 12, 2013) — A push towards institutionalising operating models, reducing fees and providing enhanced reporting and risk management has pushed one in three hedge funds to the brink, the annual EY survey on the industry has found.

“All of these have increased the cost of doing business in a time period when alpha generation has been a challenge, resulting in an overall decrease in revenues and a squeeze on profit margins,” the survey said.

In the past year, two in three managers reported higher revenues as assets and performance improved. However, EY said just half of managers reported improvements in margins; one in three said margins had declined, while a further 10% said margins had remained static but costs had increased.

This could signal change in the industry, EY said. “Increasing costs and continued downward pressure on fees mean a perfect storm for hedge fund managers that will force consolidation—particularly for managers that have not reached critical mass in assets under management—and increase the barriers to entry for the small and nimble start-ups that some investors clearly seek out.”

The picture for hedge funds was different dependent on geography. Just one in three European hedge fund managers found costs had increased, compared with 58% of North American firms. In Asia, although three-quarters of managers cited higher costs, their fundraising and revenue growth was strong enough to take the hit.

The largest cost burden has been to implement and fall in line with regulation—but has it all been worth the trouble? EY reported that more than two-thirds of investors said regulation had had no impact on their due diligence process for vetting investments. However, both sides of the deal said they felt their interests were more aligned than before the crisis.

Where the parties are not aligned, the survey found, is in the level of products that investors will eventually take up.

Hedge funds have been expanding their ranges to offer multiple products to existing clients—but their clients are not very interested, EY found.

“While managers seem determined to diversify their offerings, investors are much less interested in buying multiple products from the same manager,” said Michael Serota, EY’s global hedge fund services co-leader. “Instead, they seek the best type of manager for particular strategies. This explains why managers attract money from new clients at almost the same rate as they do from existing clients.”

For the entire survey, click here.