Arthur Tully,
Partner, Co-Leader of Global Hedge Fund Practice and Leader of Asset Management Practice, Ernst & Young LLP
Moderator:
Robert Matza, Partner and President, GoldenTree Asset Management LP
Simon Ruddick, center, of Albourne Partners says the performance of hedge fund managers over time justifies their fees. With him are Anthony Scaramucci, left, of Skybridge Capital Group and Timothy Barrett of the San Bernardino County Employees' Retirement Association.
With the dramatically increased volatility in equity markets over the past year and a half, pressure has increased to evolve business relationships with and improve due diligence regarding hedge funds and funds of funds. Nevertheless, the panelists in this session felt there are great investment opportunities with hedge funds, assuming transaction participants are able to negotiate favorable terms. The speakers noted that calls for due diligence standardization and financial protection ought to be tempered by the fact that the hedge fund industry is and will likely remain reliant on human elements and relationships.
One of the drivers of the proposed changes has been that investors are reexamining their portfolios. Timothy Barrett of the San Bernardino County Employees' Retirement Association stated that in a traditional 60/40 portfolio, more than 90 percent of the risk comes from equity. Based on that evaluation, Barrett's investment group has been shifting assets since 2002, and now allocates only 20 percent to equity. That trend is expected to continue, as is the wave of clients shifting to macros and CTAs for investment guidance.
The panel also discussed recent pressure for hedge funds to provide separate accounts for larger institutions. According the Barrett, the need for liquidity is driving pensions to call for separate accounts. Arthur Tully of Ernst & Young's Global Hedge Fund Practice emphasized that this provided an important opportunity for investors to talk to fund managers and restructure fund terms, while Simon Ruddick of Albourne Partners countered that the costs of operating segregated assets would render the idea more talk than action.
The pressure to have discussions with fund managers also spills over into due diligence. Fund managers are dealing with "tons of requests for due diligence," according to Tully. The managers have been trying to create as much investor confidence in their numbers as possible, including more information around risk and risk aggregation and counterparty assessments.
However, it is difficult to streamline the due diligence process for the simple fact that the best information results from the human review process. Although the recently released FAS 157 provides guidelines for valuing level 2 and level 3 assets, the valuations still rely on the quantitative knowledge of the fund managers. Increased documentation under the FAS rule will be more extensive, but the role of human relationships in the due diligence process and subsequent reviews cannot be replaced.
The panel also discussed the structure of hedge fund management fees. Managers have come under increasing pressure to justify their fees. In today's environment, hedge funds are open to the concept of other fee structures, like hurdle rates or third-party administrators. However, the industry may not be so quick to move away from fee structures. Ruddick points out the "inconvenient truth" that the fund managers' performance over time actually justifies their fees. However, Tully pointed out that numerous surveys have shown fees to be less important considerations than the more salient issues of performance and investment philosophy.
Another area of pressure on hedge funds, according to Anthony Scaramucci of Skybridge Capital is investors looking to empower limited partners by offering direct seeding to the funds in order to obtain similar transaction terms as general partners. Barrett countered that his experience had not produced any successful seeding yet due to the costs involved in vetting such transaction terms. Ruddick agreed, offering that while it is a great investment opportunity, it will not be easy for incubators to raise capital in the near future.
Despite all of the pressure on the hedge fund market, Scaramucci emphasized the opportunities in the market. He sees particular promise with small funds, which studies have shown to perform better in their early years than larger funds that tend to hug the major indices.
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