EDHEC RISK: Hedge funds and mutual funds converge
30 April 2010
Dr Arjuna Sittampalam argues that convergence of mainstream asset management and alternative hedge funds has been much debated but has not been realised on any significant scale until recently. Several forces are accelerating the trend on both sides of the Atlantic, one of these being fees.
Convergence of mainstream asset management and alternative hedge funds has been much talked about for some years, but has not been realised on any significant scale until recently. Several forces are accelerating the trend on both sides of the Atlantic.
If fees do not come down, there is not much point to this convergence story from the perspective of end-users’ interests, given that most hedge funds do not justify what they get. If the main asset managers charged hedge fund-type fees, they would in turn expose themselves to criticisms faced by hedge funds in the past.
The point of hedge funds in the past was not just their innovative strategies, but that a few highly talented individuals were being given unconstrained opportunities to make big money for themselves and their clients. It would be difficult for such players to be incorporated within a mainstream fund management house, given issues such as risk to reputation should things go wrong, and pay comparisons with other, non-hedge fund managers.
The hedge fund industry has over-expanded, with many mediocrities coming in, and the convergence trend should in the long run lead to these average players being squeezed out by the mainstream houses. But a slimmer hedge fund industry with the highly talented and the pioneering entrepreneurial types is likely to remain separate.
Whether long-only customers are more loyal is a moot point, considering the massive outflows that mutual funds have suffered from during the crisis, and institutions’ penchant for hiring and firing fund managers on the back of short-term performance figures.
Though hedge fund managers not liking to short may have been secret, it is not surprising. While there is no shortage of recent academic work pointing out the theoretical logic of allowing shorting, to maximise the use of stock selection skills, such research largely overlooks the practical difficulties of going short.
It would be dangerous if the conflict of interests issue were left to the companies concerned. Strict regulatory oversight seems called for. How strong is the convergence story?
Large swathes in the hedge fund sector cannot be exported to mutual funds - those involving leverage or illiquid securities, as mentioned above, and global macro funds taking huge bets.
Likewise, there are major areas within mutual funds that are also out of bounds to hedge fund managers. The point here is that the phrase ‘hedge fund’ is a misnomer. ‘Hedge’ implies some risk reduction and hedge funds offer anything but that. The crux is that safety and performance fees are mutual contradictions, and large numbers of mutual fund clients seek safety.
There are two other kinds of players in this game, structured products and ETFs, which have some characteristics in common with mutual funds and hedge funds, but other features that are different.
So, while highly fashionable, the convergence story is very much overblown and the rivalry between the four sectors is likely to be part of the investment scene permanently, though their relative size might vary.
© EDHEC
