Hedge fund and private equity firms face a tough future of higher costs and lower profits as they struggle to cope with investor demands for better supervision of their assets and lower asset bases.
Small firms in particular face cost pressure to meet increasing demand for managed accounts — individual portfolios that give clients closer control of assets — and pressure to cut lucrative fees.
At the same time, private equity firms are not able to sell as many companies, hitting bonus pools, while hedge funds have found the client assets from which they harvest management fees greatly reduced.
"Investor expectations of governance have increased dramatically ... It's quite hard for single-strategy boutiques to meet those expectations," Charles Kirwan-Taylor, chief investment officer of RAB Capital, told the Reuters Hedge Fund and Private Equity Summit in London.
"It's much easier to sustain the infrastructure as a medium-sized firm than it is as a small firm as (pressure for lower fees and managed accounts and transparency) take hold on the cost side."
Whilst clients have stopped pulling money out of the $1.6 trillion hedge fund industry and in the fourth quarter of last year reinvested a net $13.8 billion, asset levels for most hedge fund firms are well below boom levels.
RAB's assets, for instance, have fallen to $1.4 billion from more than $7 billion in December 2007.
To win back client assets firms must increasingly show their operations are strong enough that a Bernard Madoff-style fraud cannot be carried out, or offer managed accounts, which give investors the reassurance they cannot suddenly be denied access to their assets, as was widespread in the credit crisis.
Such accounts often cost more to run. According to Chris Goekjian, chief investment officer of Cheyne Capital, funds can pass on some costs to investors, but "absolutely" have to absorb other costs into their margins.
"(Managed accounts are) more expensive for us to run. We're processing more trades, we're doing more NAVs (net asset values)," he said. "There's 100 of those 170 people we have (at Cheyne) who do legal, regulatory, accounting ... trade settlement."
Private equity firms are similarly facing life on lower incomes and more demanding investors, particularly large pension funds and sovereign wealth funds demanding special terms.
"There are less deal fees. General partners are sharing more of the deal fees with limited partners which they should ... That certainly has cut into the fees for the general partners," said Bob Long, president and CEO of Conversus Capital.
There have also been fewer portfolio company sales for the industry, reducing bonuses for the firms, Long said.
"None of those can be positives for the industry," Long added.
Conversus cut its management fee last year by 20 percent and believes it has picked up new investors as a result.
"Ultimately if you want to succeed in the long term, you have to do the right thing for your investors, whether they pressure you or not," Long said.
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