Hedge fund managers—no strangers to upheaval since the outset of the global financial crisis—have a new reality to contend with, according to a recent survey. Far from shying away from the alternative asset class, many institutional investors are looking to increase allocations to hedge funds, but they are dictating the terms and demanding change as they do so.

SEI Investments’ The Era of the Investor: New Rules of Institutional Hedge Fund Investing poll of senior investment professionals at 96 institutions finds that while 80% of respondents say they have no plans to change their hedge fund allocations in the next 12 months and 15% expect to increase their allocations, there is a price to be paid for their loyalty: they want to see what’s under the hood.

Show me the money
Transparency is by far the greatest concern amongst investors, with more than 70% saying they have requested more detailed information from managers than they did a year ago. Types of data sought ranged from counterparty and leverage exposure data to sector and position-level detail, and more than 80% of respondents reported a focus on funds’ valuation methodologies.

Investors also place a high priority on finding managers with strong credentials and a demonstrable source of alpha, in addition to operational quality. Compliance infrastructure and fees also figured highly.

But the most significant finding of the survey was the pressure brought to bear on fund managers by institutional investors, putting the latter in the driver’s seat.

“As large pension funds, corporate funds, and endowments have gained presence and influence in the hedge fund industry, they have exerted both indirect and overt pressure on fund managers to evolve their entrepreneurial operating style to a more institutional and transparent model,” the report’s authors write. “A power shift has occurred as industry practices have come under increasingly intense scrutiny by the investor segment on which the industry’s fortunes most depend.”

Proof of this movement of assertive institutional investors came in the form of the Investors’ Committee of the President’s Working Group on Financial Markets, representing an array of institutional investors and advocates. The group issued its January 2009 report, Principles and Best Practices for Hedge Fund Investors, which called on investors to push for best practices that would reduce the “systemic risk” associated with hedge funds and address investor concerns. CalPERS and several other large pension funds soon followed suit, issuing a public statement of principles urging reforms to protect pension assets, including greater disclosure and transparency regarding investments and increased regulatory oversight.

“The experiences of the last eighteen months have not only underscored the fallibility of hedge funds, but also triggered an investor empowerment movement,” write the authors. “In these uncertain times, both hedge fund managers and investors can be sure of one thing: new rules of engagement are being written.”

Copyright © 2019 Transcontinental Media G.P. Originally published on benefitscanada.com

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