Poor Hedge Fund Risk Management Turning Off Investors

(February 27, 2012)  —  Poor risk management by hedge funds is the main reason investors have turned away from the sector, research by an asset servicing company has shown.

Only one in five investors responding to a survey by SEI Investment Manager Services said hedge funds, as a sector, demonstrated good risk management.

The survey cited an Ernst & Young study that showed fears over poor risk management was the main reason investors did not allocate to a hedge fund while the managers themselves considered the issue to be the least important reason they did not win the mandate.

The SEI survey said: “Most tellingly, when respondents were asked directly whether hedge funds generally do a good job of risk management, only one in five answered affirmatively. Whilst only 28% disagreed, more than half of respondents were on the fence—hardly a rousing vote of confidence. This is a point of prime concern to the industry, as investors named ‘risk management infrastructure’ the third most important factor they weigh in evaluating and selecting hedge funds.”

The survey said risk management was a sweeping term that encompassed issues at every level of hedge fund management—from firm structure and investment strategy to portfolio management and operations. It said that investors were not confident in many of these areas.

It said: “All this suggests that, going forward, risk management infrastructure deserves to be an even greater focus of investor and hedge fund due diligence than it has been in the past.”

Risk management rose above transparency and liquidity in a list of important factors to consider when allocating to hedge funds. This showed that while these concerns were still on investors’ minds following demands for improvement over the financial crisis, risk management is a more key factor.

Performance was also flagged as a reason for investors staying away by the survey. According to Hedge Fund Research, the average return in the sector was a negative 4.8% in 2011, against the S&P 500 that closed the year relatively flat.

The financial crisis has taken its toll on the hedge fund industry’s image – more than one in four investors surveyed said performance was now one of their major concerns , double the number in 2009.

Some 61% also considered there to be too many copy-cat strategies in the market, suggesting investors may move their money and funds may soon face consolidation.