In the aftermath of 2008 and the implementation of the UA Dodd-Frank Act, the hedge fund landscape has been permanently altered. Now forced to abide by the rules and restrictions of the European AIFMD, larger hedge funds have had to give up some of their more effective tactics, like using leverage as a tool to eclipse their competition.
These dramatic actions have resulted in a leveling of the playing field. This opportunity has given rise to new players in the game, and, as such, increased the competition in this new, more fair hedge fund space.
What does this increased competition look like, and what does this mean for the hedge funds of today?
Smaller hedge funds making headway
In wake of stricter regulations, a growing trend has emerged: prime brokerages opting for smaller hedge funds.
While not always the case, smaller hedge funds have distinct advantages over their larger competitors. While the larger players possess mightier resources and sizeable teams, these resources can act as a double-edged sword, ultimately proving cumbersome in some cases.
A smaller hedge fund has the ability to operate within a single regulatory framework, dealing unilaterally with both risk and reporting environments. In short, this equates to having a more holistic understanding within a smaller team, thus providing the opportunity to be more agile and reactionary.
An increased focus on technology
As hedge funds attempt to juggle multiple service providers, analytics and processes become much more tortuous. Technology allows the operations side to manage resources more effectively and tackle the complicated problems that arise with managing multiple accounts. This allows the large hedge to be effective across their entire client base.
But technology is also a major expenditure. KPMG recently found that nearly 40 percent of hedge funds plan to invest over one million dollars annually in technology for the next five years. That accumulates to a spending boost of around 35 percent.
In some cases (especially with larger hedge funds), technological fees account for nearly a quarter of the overall management fee. This makes sense when considering the overall framework: over half of the staff in larger hedge funds aren’t involved in asset growth, they’re focused on tech and data management.
Branching payment structures
Originally, there were only two options when it came to hedge funds. One option was to work with an intermediary of a large bank, which meant ultimately having to pay both the prime broker and the intermediary. The other was to go with one of the big names in the industry and incur the massive fees associated with their expertise.
Now, increased regulation has allowed smaller hedge funds to see more action. This has allowed them to change up their payment structures in order to win accounts. One strategy some have used to eliminate the markup on the intermediary by cutting them out altogether. In doing so, their rates can be more dynamic. It also allows smaller hedge funds to operate on a case-by-case basis, giving them a more docile framework of payment structures.
More customized strategies
As smaller hedge funds become a more viable choice in this post-recession world, they’ve taken great lengths to diversify their strategies. They can custom tailor it to their clients in a way the larger, more established funds might not be nimble enough to operate.
And it’s having dramatic results on the output. A recent study showed a significant discrepancy between the output produced between large and small funds. While the brand name agencies (unsurprisingly) brought in a significantly larger quantity of money, in terms of returns, they only hit a return percentage of 7.32, whereas the smaller portfolios earned an impressive 9 percent.
Obviously, these are overall figures and can’t paint an accurate picture of what each individual hedge fund is capable of. However, it does show that, coupled with the boost in technological spending and the diversification of options existing within the hedge fund space, that seismic shifts are happening in this very dynamic market.