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Mid-sized hedge funds must determine commitment to building infrastructure necessary for winning institutional clients.
New research released by RSM McGladrey, a leading professional services firm providing tax and consulting services under the McGladrey brand, reveals that mid-sized hedge funds with $100-$500 million in assets are facing a “reality gap.” While nearly 95 percent of the hedge funds surveyed by Greenwich Associates believe they can meet institutional investors’ demands, only 22 percent have more than one full-time employee responsible for client service, and only 9 percent have highly automated reporting systems.
“Attracting institutional assets will require new ongoing personnel expenses for the majority of mid-sized hedge funds, as well as significant up-front investments in technology to increase reporting capabilities,” said Alan Alzfan, a managing director in the Financial Services Group at RSM McGladrey, Inc. “Mid-sized hedge funds must understand that implementing best practices for a truly institutional platform is not an overnight process — it can take more than a year in many cases.”
More than 90 percent of the 52 U.S. hedge funds surveyed have an unfocused business model, targeting all investors: institutional, fund of funds and High Net Worth individuals (HNW)/family office. Nearly one quarter of respondents (23 percent) have seen an increase in institutional clients over the past two years, with 17 percent reporting a decrease. While there has been a net gain in institutional investment in mid-sized hedge funds, the diverging responses highlight the significance of having an institutional infrastructure: nearly half (47 percent) of funds for whom institutional investors represent a majority of clients say having a dedicated client service team is “critically important” in winning assignments, with less than one-quarter (24 percent) of funds with primarily HNW investors saying the same. On average, funds with two or more full-time sales professionals won more than 10 mandates in the past year; funds with fewer salespeople won seven.
Additionally, 37 percent of mid-sized hedge funds report more burdensome reporting requirements regarding performance and risk. Almost 85 percent believe that their current infrastructure is sufficiently scalable to handle client reporting needs for the next five years, yet 26 percent report having either “manual” or “highly manual” reporting systems.
“Mid-sized funds represent a significant segment of the hedge fund market, and they are facing unprecedented pressures,” said Alzfan. “These funds need to analyze the necessary steps for developing best practices at their organizations if they want to attract institutional assets.”
Such steps include increasing staff to levels that are at least competitive with the current average of 1.5 to 2 full-time employees devoted to marketing among hedge funds that target institutional investors, and creating separation among internal functions to demonstrate that appropriate checks and controls are in place.
The Risks and Rewards of Institutional Investors
Nearly two thirds (64 percent) of hedge fund managers state that institutional clients are “more burdensome” than HNW/family office clients, often providing questionnaires of 30-40 pages in length during the due diligence process and calling provided references.
There is also a new emphasis on liquidity, with one-third of funds planning to allow liquidity on a more frequent basis and reducing their lock-up periods as a means of attracting investors.
“Institutional clients tend to be more demanding about liquidity,” says Alzfan. “But during the financial crisis, the funds with the loosest terms suffered the most redemptions.”
Forty-one percent of funds that experienced terminations over the past two years attributed clients’ decisions to liquidity needs.
“Some managers will choose to limit or even cease activity in the institutional space given the changes that are necessary to the funds’ business model to compete for institutional assets,” said Alzfan. “But managers who want to gain consistent access to institutions’ large allocations of capital and the resulting fees – both management and incentive – will have little choice but to take on at least some of the risks involved in investing in their funds’ infrastructure and adjusting their liquidity terms.”
Research Methodology
McGladrey’s 2010 Hedge Fund Survey was conducted from June to July 2010. In conducting the study, Greenwich Associates interviewed 52 U.S. hedge fund executives by telephone. All the funds had AUMs between $100 million and $500 million, with an average AUM of $300 million.
View the complete 2010 McGladrey Hedge Fund Survey Whitepaper in full.
About Greenwich Associates
Greenwich Associates provides research-based strategy management services for financial professionals. Greenwich Associates’ studies provide benefits to the buyers and sellers of financial services in the form of benchmark information on best practices and market intelligence on overall trends. Based in Stamford, Connecticut, with additional offices in London, Toronto, Tokyo, and Singapore, the firm offers over 100 research-based consulting programs to more than 250 global financial services companies. Follow them: http://twitter.com/greenwichassoc.
About McGladrey
McGladrey is the brand under which RSM McGladrey, Inc., and McGladrey & Pullen, LLP, serve clients’ business needs. Together, they rank as the fifth largest U.S. provider of assurance, tax and consulting services, with 7,000 professionals and associates in nearly 90 offices. The two firms operate as separate legal entities in an alternative practice structure. McGladrey & Pullen is a licensed CPA firm that provides assurance services. RSM McGladrey is a leading professional services firm providing tax and consulting services. Both firms are members of RSM International, the sixth largest global network of independent accounting, tax and consulting firms.
