Mid-Sized Hedge Funds at Crossroads; Must Reassess Business Models, According to McGladrey Survey

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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.

Deloitte’s Launches Hedge Fund Emerging Manager Platform

Deloitte's asset management services practice has launched a global full-service hedge fund emerging manager platform offering a unique mix of traditional and non-traditional professional services across audit, tax, financial advisory and consulting. The program represents the latest development in an aggressive two-year build out of the hedge fund practice.

“In today’s environment, emerging managers need recognized industry heavyweights for professional services. Deloitte has launched the hedge fund emerging manager platform to provide emerging managers with a solution that offers access to our global network, and customized, creative and responsive service,” said Cary Stier, vice chairman and Deloitte’s U.S. asset management services leader. “If you launch with Deloitte, you stay with Deloitte. A client cannot outgrow our services. Deloitte delivers results that matter.”

The emerging manager platform offers traditional services like audit, tax compliance and fund structuring bundled with non-traditional services including general partner and international tax planning, regulatory and compliance, and technology and operations on a sliding fee scale that keeps pace with the manager’s growth. The emerging manager platform is led by 23 partners, principals and directors and more than 250 specialists internationally through the Deloitte Touche Tohmatsu Limited (DTTL) member firms with operations in the United States, Dublin, London, Hong Kong, Luxembourg, Bermuda, Cyprus, Mauritius and the Cayman Islands.

“Today emerging managers face the pressure of having to operate like a mature fund before they can fully absorb the associated costs, which is why we have designed this global program to offer full service at a sliding cost. It will be difficult for emerging managers to succeed without access to the right services; we understand that and are committed to meeting that need,” said Ray Iler, director, Deloitte & Touche LLP and leader of the hedge fund emerging manager platform in the U.S. “From the investor perspective, a new manager’s choice of Deloitte provides instant creditability and confidence. And, for institutions seeding emerging managers, we can offer consistent tax and financial reporting and standardized service offerings regardless of geography.”

Deloitte’s hedge fund practice offers access to a global bench of talent in audit and tax, valuation, anti-fraud, governance and oversight, regulatory and compliance, risk management, technology and operations, structuring, and assessment of third party administrator/prime brokerage relationships. With a DTTL member firm network of more than 3,500 specialists in more than 40 countries, the practice serves 70 percent of U.S. hedge funds with more than $20 billion in assets under management, and 75 percent of global hedge funds with more than $20 billion in assets under management.

BlackRock Reports Assets Under Management of $3.446 Trillion at September 30, 2010

BlackRock, Inc. today reported third quarter 2010 net income(1) of $551 million, up $234 million from a year ago and up $119 million compared to second quarter 2010. Operating income was $707 million and non-operating income, net of non-controlling interests, was $45 million. The operating margin was 33.8%, which included the effect of $17 million of costs related to the successful launch of the $1.2 billion Build America Bond Trust and $6 million of integration costs associated with the December 1, 2009 acquisition of Barclays Global Investors ("BGI").

Third quarter net income, as adjusted(2), was $2.75 per diluted common share, or $537 million, up 31% compared to third quarter 2009 diluted EPS, as adjusted(2), of $2.10 and up $0.38 compared to second quarter 2010. Third quarter 2010 included operating income, as adjusted(2), of $2.61 per diluted share and net non-operating income, as adjusted(2), of $0.14 per diluted share. Third quarter net income includes a tax rate benefit ($0.11 per diluted share related to first half of 2010) reflecting favorable tax rulings and resolution of certain tax positions. Operating income, as adjusted(2), of $737 million, which included $17 million of closed-end fund launch costs, improved $337 million, or 84%, compared to third quarter 2009 and declined $4 million, or 1%, compared to second quarter 2010. Compared to a year ago, operating results reflect the benefits of the BGI acquisition and improved markets. The operating margin, as adjusted(2), for year-to-date September 2010 was 38.7%, an expansion as compared to 37.4% in 2009. Third quarter income and year-to-date margin reflect positive business momentum, the benefits of our diversified business model and continued investment in the business. Non-operating income, net of non-controlling interests, as adjusted(2), in the third quarter 2010 included gains of approximately $66 million as a result of higher valuations on co-investments including private equity, distressed opportunistic funds as well as real estate equity products.

Assets under management ("AUM") totaled $3.446 trillion at September 30, 2010, up $295.5 billion or 9% during the quarter and $2.011 trillion or 140% year-over-year, including $1.756 trillion of acquired AUM net of outflows due to manager concentration considerations and active quantitative performance ("merger-related outflows"). As discussed under "Third Quarter Business Highlights," net new business during the quarter totaled $50.1 billion, including $52.6 billion in long-term products and $1.8 billion in cash management, partially offset by $4.3 billion of net distributions in advisory AUM. BlackRock Solutions(R) added 4 net new assignments during the quarter, bringing the total for the year to 34 net new mandates. Investment performance remained competitive across much of the platform, supporting new business efforts in all regions. At October 15, 2010, the pipeline of net wins funded or to be funded totaled $46.1 billion, including $40.7 billion in long-term products and $5.4 billion in cash management.

Hedge funds recorded the largest quarterly asset jump in over three year

Hedge funds recorded the largest quarterly asset jump in over three years, with total industry capital increasing by $120 billion in 3Q10 according to data released today by Hedge Fund Research, Inc. (HFR). The capital increase reflects a combination of both performance-based gains and new capital inflows, bringing total assets invested in the hedge fund industry to $1.77 trillion as of 3Q10.

The HFRI Fund Weighted Composite Index posted a gain of +5.17 percent in the third quarter, bringing the cumulative Net Asset Value (NAV) of the broad-based index to exceed the previous record level set in October 2007. After three years, the industry has emerged from the worst cumulative performance drawdown in its history, which had exceeded -21.4 percent through the volatility of the financial crisis.

RBC HEDGE 250 INDEX® RETURNED 2.20 PERCENT IN SEPTEMBER 2010

The RBC Hedge 250 Index® had a net return of 2.20 percent for the month of September 2010. This brings the year-to-date return of the Index to 2.54 percent. These returns are estimated and will be finalized by the middle of next month. The return for August 2010 has been finalized at 0.12 percent.

The RBC Hedge 250 Index is a non-investable benchmark of the performance of the hedge fund industry. The Index operates in accordance with a unique construction methodology. The Universe on which the Index is based currently consists of 3,791 hedge funds (excludes funds of hedge funds) with aggregate assets under management of $892 billion.

_____Index Level Sep-10 Aug-10 YTD ITD
Hedge 250 122.19 2.20% 0.12% 2.54% 22.19%

Relative Value

Convertible Arbitrage 0.42% 0.62% -1.45% 17.16%
Equity Market Neutral 1.92% -0.73% -0.72% 7.96%
Fixed Income Arbitrage 1.44% 1.40% 12.52% 26.11%

Tactical

Equity Long/Short 3.45% -0.77% 1.12% 46.70%
Macro 1.21% 1.35% 1.58% 14.20%
Managed Futures 2.13% 3.39% 3.77% 63.81%

Event Driven

Credit 1.81% -0.36% 6.50% 7.83%
Mergers & Special Situations 3.54% -0.79% 5.27% 37.38%

Multi-Strategy

Multi-Strategy 1.01% 0.30% 3.64% 3.69%

Table contains estimated returns, except for the August returns, which are final.

Inception Date is July 1, 2005. Index Level at inception was 100.00.

The Dow Jones Credit Suisse Hedge Fund Index rose 3.43% in September

The Dow Jones Credit Suisse Hedge Fund Index rose 3.43% in September, with nine out of ten sectors posting positive performance for the month. Among the top performing sectors were Long/Short Equity (+5.09%) and Emerging Markets (+4.77%), which benefited from long directional exposure to the global equity market rally in September. The Event Driven sector finished up 3.20% as managers continued to capitalize on increasing activity in the M&A and distressed debt space.

Performance for the Broad Index and its ten sub-strategies is calculated monthly. September, August, and year-to-date performance numbers are listed below and are available at www.hedgeindex.com.

Index	September 2010	August 2010	YTD
Broad Index	3.43%	0.23%	5.98%
Convertible Arbitrage	1.11%	1.35%	7.51%
Dedicated Short Bias	-11.28%	5.15%	-12.49%
Emerging Markets	4.77%	0.12%	7.72%
Equity Market Neutral	3.66%	-1.55%	-0.96%
Event Driven	3.20%	-0.40%	6.31%
Distressed	2.07%	-0.64%	5.58%
Event Driven Multi-Strategy	4.03%	-0.24%	6.78%
Risk Arbitrage	2.31%	0.31%	4.14%
Fixed Income Arbitrage	1.55%	1.24%	9.79%
Global Macro	2.72%	1.48%	9.33%
Long/Short Equity	5.09%	-1.12%	3.12%
Managed Futures	2.77%	4.87%	6.44%
Multi-Strategy	2.79%	0.01%	5.01%
Dow Jones Industrial Average*	7.85%	-3.91%	5.57%
Dow Jones World Index	9.54%	-3.62%	2.89%
*Total Return Index

No funds were added to the Broad Index in September.

The following funds are no longer reporting to the Broad Index: Compass Income Master Fund, Inc., Amber Master Fund SPC, Iridian Opportunity Fund.

The Broad Index is constructed using the Credit Suisse database of more than 8,000 hedge funds. It includes both open and closed funds located in the U.S. and offshore, but does not include fund of funds. In order to qualify for inclusion in the index selection universe, a fund must have a minimum of USD 50 million under management, a 12-month track record, and audited financial statements. Index funds are selected using a formula based on assets under management, which ensures that the Index represents at least 85% of total assets in each of ten strategy-based sectors in the selection universe. In order to minimize survivorship bias, funds are not excluded until they liquidate or fail to meet the reporting requirements. The Broad Index is calculated as a total return index on a monthly basis, adjusted for asset in- and outflows, including a reselection according to the procedure outlined above, on a quarterly basis.

The Dow Jones Credit Suisse family of hedge fund indexes includes four separate indexes:
- The Dow Jones Credit Suisse Hedge Fund Index (formerly known as the Credit Suisse/Tremont Hedge Fund Index) is an asset-weighted benchmark that measures hedge fund performance and seeks to provide the most accurate representation of the hedge fund universe.
- The Dow Jones Credit Suisse AllHedge Index (formerly known as the Credit Suisse/Tremont AllHedge Index) is an investable index comprised of all 10 Dow Jones Credit Suisse AllHedge Strategy Indexes weighted according to the sector weights of the Broad Index.
- The Dow Jones Credit Suisse Blue Chip Hedge Fund Index (formerly known as the Credit Suisse/Tremont Investable Hedge Fund Index) is an investable index comprised of 60 of the largest funds across the ten style-based sectors in the Broad Index.
- The Dow Jones Credit Suisse LEA Hedge Fund Index (formerly known as the Credit Suisse/Tremont LEA Hedge Fund Index) is an asset-weighted, composite index which provides insight in to three specific regions of the emerging markets hedge fund universe (Latin America, EEMEA (Emerging Europe, Middle East and Africa) and Asia).

In accordance with the Dow Jones Credit Suisse Blue Chip Hedge Fund Index Rules and the Dow Jones Credit Suisse AllHedge Strategy Index Rules, Credit Suisse Hedge Index LLC is publishing the following notice:

The following funds are in a Special Rebalancing Situation: Alexandra Global Investment Fund I Ltd., Amber Fund (Cayman) Ltd., Arpeggio Fund, Basso Investors Ltd., Bennelong Asia Pacific Multi Strategy Equity Master Fund Ltd., BlueTrend Fund Ltd., Bridgewater Pure Alpha Fund II Ltd., Canyon Value Realization Fund (Cayman) Ltd., Castlerigg International Limited, Centaur Classic Convertible Arbitrage Fund Ltd., Compass Holdings Ltd., Contrarian Fund I Offshore Ltd., Deephaven Global Multi-Strategy Fund, Drawbridge Global Macro Fund Ltd. - SPV Assets, Firebird Avrora Fund Ltd, GLG European Long Short Fund Ltd., GLG Market Neutral Fund Ltd., Global GT Ltd., Gramercy Offshore Fund (SPV) SPC, JANA Offshore Partners Ltd., Jayhawk China Fund (Cayman) Ltd., Longacre International Ltd., Owl Creek Overseas Fund Ltd., Plexus Fund Ltd., Ramius Multi-Strategy Fund Ltd., Seneca Capital International, Ltd., Shepherd Select Asset Ltd., Thales International Fund Ltd., and WGTC Ltd.

Investors Say Performance Rules in Grading U.S. Hedge Funds

York Takes Top Grade in AR Magazine's Investor Survey of U.S. Hedge Funds; Major Shift in Lineup of Top-Scoring Firms Since Last Survey

Hedge fund investors have not forgotten the carnage of 2008, and the managers who learned its lessons -- as well as those who produced stellar returns -- garnered the top marks in the latest "Hedge Fund Report Card" survey in the September issue of AR Magazine.

York Capital Management, the New York hedge fund founded by Jamie Dinan that manages $11.35 billion in assets, topped the survey, with investors praising Dinan for his integrity and the firm's investment performance. York edged Bridgewater Associates out of the lead and jumped nine notches from its tenth-place ranking in last year's survey.
The Hedge Fund Report Card is a survey of hedge fund investors--including pension funds, foundations and endowments--who collectively oversee more than $250 billion in assets. For the survey, these investors scored the top 50 firms in the AR Billion Dollar Club on six factors: alignment of interests, alpha generation, independent oversight, infrastructure, transparency and liquidity terms.

Investors have changed the way they look at many of the industry's largest hedge fund firms, as evidenced by the major shift in the lineup of the top-scoring firms since last year's survey.

They have also changed their priorities about what factors they deem to be most important. Investors say their main concern now is performance, jumping into second place of the six factors that investors took into consideration when scoring the funds.
Bridgewater, headed by Ray Dalio and managing $50.9 billion, finished a close second place in this year's survey. Investors cited the firm's client service, creativity and innovation in giving the firm high marks. Rounding out the top 10 are Bain Capital/Brookside Capital Partners, Adage Capital Management, Canyon Capital Advisors and Baupost Group (tied for fifth place), King Street Capital Management, Taconic Capital Advisors and Angelo, Gordon & Co. (tied for eighth place) and Fortress Investment Group.

Fortress gained the most over the past year, climbing to 10th place from 30th last year. Another firm that jumped significantly this year is Angelo Gordon, which tied for eighth place with Taconic, up from its 24th-place ranking last year. Not surprisingly, strong performance is the reason most of these funds gained in the rankings, according to investors.

On the flip side, several prominent and highly regarded firms plummeted in this year's rankings. Tudor Investment Corp., Paulson & Co. and Highbridge Capital Management -- in second, third, and fourth place, respectively, last year -- fell significantly.