Hedge Funds and Their World: Slow Recovery Ahead

Deloitte’s asset management group hosted a breakfast press briefing recently that turned into a wide-ranging bull session regarding the state of the hedge-fund world. The conclusion that sticks in one’s mind is: things are getting better, but you can leave your go-go boots in the back of your closet for some time yet.

Hearing the bull thrown by such very well-informed people as Cary Stier, Ellen Schubert, and Ted Dougherty is an enjoyable way to spend a morning, especially when the people in question have been speaking to hundreds of the most influential investors and asset managers in New York.

What follows are my own impressions from that briefing; you will notice that I have deliberately refrained from attaching quotation marks or names to any of it.

More Upbeat Tone on Wall Street

Among the cognoscenti, it appears, things are a little more upbeat than they were a year ago. Markets are bullish on the United States in particular, though this is so only with some obvious qualifications: they don’t expect that a go-go climate will return any time soon, but they do expect a slow-and-real recovery. Likewise, the market is modestly bullish on at least the north of Europe. Yes, few market participants can work up enthusiasm about the south of Europe these days, but even there … last year there was a lot of concern that a Greek exit from the Eurozone would become a Lehman moment on a global scale. That concern now seems to have passed.

Ben Bernanke, chairman of the U.S. Federal Reserve, and Mario Draghi, president of the European Central Bank, have between them given the market grounds for such optimism as it now feels. Each has indicated in recent weeks that he is willing to use the bazookas at his disposal.

Further, our briefers suggested that the markets aren’t worried about the impending “fiscal cliff” of which we’ve all heard so much, the arithmetic that kicks in at the end of 2012 as the terms of the Budget Control Act of 2011 take effect. The market has already discounted what is now the most likely outcome of the Presidential election, (a victory for the incumbent), and with this it appears also to have incorporated the view that the administration, with the benefit of whatever backwind may have been generated by the new ‘mandate,’ will get the support it needs to turn the cliff into just a manageably inclined plane.

Acceptance and Trends

Likewise with the Volcker rule: what was once an uncertainty and even in some circles a cause of dread has now become an accepted fact. [This is the rule, enacted as part of the Dodd-Frank Act of 2010 that sharply limits proprietary trading by any bank or any institution that owns a bank, and that prohibits any bank sponsorship of a hedge or PE fund.]  Markets assent, this is here to stay, regardless of who comes and goes at the White House or in the offices of the Securities and Exchange Commission.

Fascinating discussion about longer-term trends in the market also accompanied this breakfast. For instance, the search for alpha (never easy) is becoming more difficult over time. Historically, the well-connected would get important news before the rest of the world. But the rise of the internet and now of social media, the rise also – outside the traditional financial press (which has, after all, been around for a few years) – of the more free-wheeling econoblogosphere has created an environment in which the whole world seems to know everything at the same time.

Further, what informational advantages exist through expert networks have come under furious assault from those who equate them with securities fraud and who wield the weapons of criminal law and enforcement.

Industry Specific Issues

Two more industry-specific issues also received their share of attention: succession plans and fees.

Some successful hedge fund managers don’t have or care about a succession plan. Others, though, want the sense of leaving behind an ongoing enterprise, and of leaving that in capable hands. This requires planning.

You can’t preserve that institution by selling it. After all: what are you selling? An asset management firm of any sort consists chiefly in its human capital (the filing cabinets and even the computer hardware is fungible). Yet you can’t guarantee a buyer that the human capital will stay in place. And without that, what is the buyer buying? Potential buyers are sufficiently savvy to worry about paying an exorbitant price for those filing cabinets under a partnership rubric.

On fees: there is a good deal of investor pressure for a fee schedule lower than the classical one, a management fee of 2 percent of net assets and a performance fee of 20 percent of annual net profit. After all, hedge funds themselves these days don’t often project returns higher than high single digits, a good deal lower than projections – or accomplishments – of the good old days. Investors, especially the institutions among them, push back at the notion of paying the traditional fees for lower-than-traditional results. That pressure is something to which emerging managers in particular have to respond (the older, established managers are better at holding the line.)

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