This is a guest post by Peter Laurelli, CFA. Laurelli is vice president and head of research at eVestment|HFN.
Hedge funds are not what they used to be.
Gone are the days when investing directly in a hedge fund was only for the super-rich. The influence and practices of fund to funds is in decline while consultants and large institutional investors like pension funds have more say in the hedge fund world.
But the newer investors in the hedge fund space are pushing most of their assets towards the largest hedge funds. Why? Institutional investors tend to favor strong operational structures which the large funds offer. Through July, eVestment flow data shows funds with greater than $1 billion in AUM have accounted for an estimated 101% of net investor flows in 2012. Earlier this year, the consulting firm Casey Quirk, along with eVestment, released a survey which showed alternative investments will drive up to 20% of U.S. manager search activity in 2012.
But this influx of institutional capital toward among large funds is forcing a temporary step backwards on the way data is collected, managed, analyzed and monitored.
However, there are solutions that allow for greater efficiency, while retaining privacy, and when coupled with progress being forced on the industry through regulation, could and should lead to a major evolution in hedge fund transparency.
Evidence of this consolidation is prevalent.
There are two primary consequences of this consolidation. First, there is movement towards increased opacity of industry trends and sources of performance. Large funds tend to be more diversified across exposures to security types, market sectors, investment regions, counterparties and service providers. The consolidation of assets to highly diversified firms results in a higher level of transparency needed to assess aggregated exposures across a portfolio and to distinguish trends across the industry. Additionally, if investors are able to capture exposure information in-house, managing the information on a monthly basis multiplies the challenges mentioned before, namely, resource drain and inconsistencies across firms.
Second, there is less efficiency and consistency in the collection and management of information from a growing segment of the industry. Many of the largest firms tend not to report to commercial databases. If they do report, they tend not to report all their products, or in many cases, their largest products. As a result, allocators or consultants rely on internally collected and managed databases that are then combined with commercial datasets. Management of internal datasets is resource intensive and, depending on the level of the relationship and communication between fund and investor, inconsistencies may arise in the data across firms.
What are solutions to these problems?
In an ideal world, all funds would take advantage of the technology advances in the administration industry surrounding data aggregation and the dissemination of Form PF and allow administrators to directly distribute certain information to third party data providers for investors to access in analytical software platforms.
In reality, this is not a likely near term solution, but it can be, and it should be.
Thanks to Form PF, the burden of building the technology infrastructure to calculate and format aggregated fund-level security, market and sector exposures, and other non-financial risks, has been addressed by fund administrators.
With technology from firms, like eVestment, for example, the weight of data management and formatting for investors and privacy concerns for funds are alleviated. Additionally, for hedge funds firms who only want targeted transparency, information can be kept segregated in private portals and made available only to the investor, or only to multiple investors the fund allows.
The primary benefits of increased transparency through third parties are clear for all involved. Increased efficiency of operations allows investors and consultants to focus on their core competencies, and when funds provide the proper information to investors in a timely manner, investors make confident decisions, which ultimately lead to stronger relationships between fund, consultant and investor.
The hedge fund industry is on the edge of a transparency frontier, but the current practice for how the majority of information on large funds is being handled is inefficient at best. The tools are in place for the next step forward, but it requires the influence of investors along with the willingness of funds, yet I believe it can and should happen very soon.
