Back in 1909, when radio was still in its infancy and steam ships were big news, the U.S. replaced Britain to become the economic leader of the century. The world’s financial headquarters were officially in New York, not London.
Globalization shifts power to the east
However, in the 21st Century, especially during and after the Great Recession, we have experienced a shift in world economic power from west to east. The U.S. and Europe have clearly seen economic trouble and the center of power has moved further east to make cities like Beijing and Shanghai new global economic hubs.
The growth of technology and the acceleration of globalization has resulted in greater interconnection of global markets through a boost in communication and better awareness of the opportunities present in different corners of the globe.
This has led to both opportunities and challenges as division of labor enhances efficiency but competition grows. With access to global markets, everyday investors can tap into larger and more diverse markets. Using an unprecedented wealth of information, investors can effectively assess investments across a multinational portfolio.
Climate change matters to consumers
Climate change has also had an effect on how investors prepare for the future, calling on all companies to be more active in preserving the environment. Whether voluntarily or not, many companies have heard and responded to the call.
While climate change continues to make headlines across the world, a keen observer may notice that it has very little (if any) coverage in traditional investment books. The modern investor must take climate change into account when making investment decisions.
The Principles for Responsible Investment (PRI) released a guide to help investors reduce emissions in their portfolios. The paper, titled Developing an Asset Owner Climate Change Strategy, states thats, “Response to climate change must be tailored to an asset owner’s investment approach and asset class mix. This could involve: Measuring a portfolio carbon footprint; engaging with policy makers and companies on transitioning to a low carbon economy; and accelerating newer forms of investment.”
Where’s the good news for the modern investor?
When investing in the 21st Century, there are two main things to keep in mind. One is that the investing playbook is very outdated because of the dramatic shift in financial power towards the east. If you’ve never looked into Asian stocks before today—now’s your big chance. Savvy investors can still seize opportunities that accompany global change and stride the wave of growth.
The energy market is also completely transforming, and the word “clean” has a lot to do with it. Where once we spent all our time and money on oil investments, everyone is now moving their money to alternative fuels that preserve and protect the environment. For the 21st century investor to succeed, they have to recognize the changing times, commodities, and technologies that surround them.
The second thing to keep in mind is that diversification remains the smartest way to go. If the financial crisis taught investors anything, it’s that keeping all your eggs in one basket is a terrible idea unless you’re prescient. By diversifying portfolios, investors hedge their bets against uncertain times of growth, and a cushion to protect them as they go through various unanticipated peaks and troughs.
It’s also worth pointing out that add that the days when an investor left everything in the hands of their financial manager are gone. The modern investor has to be proactive in managing their own funds—even if they are going to hand it off to someone else—and know all there is to know about their investments and the risk they carry.
Invest like it’s the 21st century
We’re already almost two decades into the 21st century, but we have to look even further ahead at the potential opportunities and challenges in years to come. We must reflect on past events and the opportunities we’ve already missed. Generally, the future looks very bright. But only if we’re willing to let go of some of our 20th Century investment habits.
Private equity and hedge funds are both attractive options for high-net worth individuals, with many requiring a minimum of $250,000 in investments. However, while they have a couple of similarities, the two are fundamentally different types of funds.
Sometimes it’s unclear which of the two is the better option.
Let’s look at the key differences, as well as how the recession and recent legislation have affected both the immediate and long-term attractiveness of private equity and hedge funds as investment vehicles.
What’s the difference between private equity and hedge funds?
A private equity fund is a capital amount that an investor invests in a business with the aim of gaining equity ownership in the business. The funds are applied for different purposes, such as improving the balance sheet or ensuring smooth operations.
On the other hand, hedge funds (also referred to as investment partnerships) are focused on giving the investor an attractive investment vehicle that’s typically uncorrelated with the larger market. To achieve this, hedge funds typically specialize in a specific type of investment, usually in highly liquid assets all the way to esoteric illiquid securities. This allows the fund to gain a profit even in a bear market.
Unlike hedge funds, private equity is illiquid. Investors may not be able to recoup their money until a company has an exit.
Private equity funds are closely related to venture capital, and have similar long-term growth and exit goals. These kinds of investments are also uncorrelated with the market but are usually long-term, typically taking a minimum of 3–10 years before sale of assets. Accredited investors and institutional investors are most common to private equity, mostly because they best understand the implications and can afford to keep funds invested for long periods of time.
While both types of funds take measures to manage risk, hedge funds are usually more exposed to risk since they focus on short-term gains and mark to market. However, while a hedge fund manager can shield investors by anticipating profit levels basing on current conditions, private equity is highly speculative and investors often don’t know what their returns will look like until years later.
Private equity investment requires large capital commitments. Most private equity firms typically want investors who are willing to commit upwards of $25 million. Some firms have however dropped their minimum requirements to $250,000––which might still be out of reach for many average investors.
Hedge funds usually require a lower minimum of $100,000. But many hedge funds will require$1 million as the minimum investment––still nowhere near $25 million, though.
Both funds have a similar fee structure, and typically require a management fee and a performance fee. The annual management fee for private equity firms is around 2% with a performance fee (or carried interest) of around 20% of the investment profits.
The “Two and Twenty” phrase is used in the hedge fund world to convey that hedge fund managers typically charge a 2% flat fee of the total value of assets and 20% performance fee on earned profits. However, in some cases, the 20% fee is charged only after the performance exceeds a certain threshold, which is typically around 7-8%.
What do investors expect from each type of firm?
Governments and regulators have reinforced the regulations of private equity firms, citing what was seen by many as over-favorable taxation. Investors have also pressured the industry to provide more transparency regarding fees and expenses. These new regulations will see investors deal with more transparent fund managers moving forward.
The current regulatory environment also presents a new set of challenges to hedge fund managers. Not only have they had to come to terms with the Dodd-Frank Act, they also have to comply with new registration and disclosure requirements. Investors are now more proactive in the selection and redemption criteria and are more likely to try and negotiate management fees as well.
In light of these new regulations, we can expect to see fund managers become more transparent and investors tighten -up their due diligence.
What’s the current outlook for private equity and for hedge funds?
In the past, private equity has maintained a track record of outperforming all other asset classes; this is generally has not been the case recently. Recently, hedge fund returns have shrunk due to rising competition, market conditions, and regulation. Some critics argue that it’s unlikely hedge funds will return to their peak levels.
As institutional investors and high net worth individuals are expected to make bigger commitments in private equity, a study conducted by Barclays last year found that 48% of investors plan to make more allocations into hedge funds this year. This is an improvement compared to the 33% who voiced similar intentions in 2015.
The report goes on to say that while the asset level reached a new high last year, the industry also experienced outflows for the first time since the 2008 financial crisis. However, the report continues, there’s promise for net inflows in 2017.
It’s 9 years later, and we can still feel the impact of the 2008-2009 financial downturn. Many people blamed structured products for the crisis. In reality, the real fault lies within loose underwriting standards and corporate greed. The lingering association, while no longer completely accurate in the here and now, is a large hurdle to overcome.
The reality is that structured products have changed. Rules and regulations have been set to mitigate the risk of the financial crisis, while the benefits (that always existed) are being rediscovered and repurposed.
Part of this shift comes from the increasing focus on providing investors with more transparency. Another part comes from being able to look at the crisis (and by extension, structured products) in hindsight.
Let’s take a look at the past, present, and future of structured products in America.
Structured products are still doing reputational damage control
Structured products are not flawless; there are valid concerns about liquidity band complexity. However, there are also many positive aspects to structured products that make them a viable offering.
Recently, there has been a shift in rules and regulations. Now, laws dictate that investors receive more clarity prior to making the investment, for example having access to the estimated value disclosures. The goal here is simple: put rules in place to help prevent another disaster.
Most institutions have realized that the best defense on the reputation of structured products is a good offense. They are helping their customers understand exactly what structured products are, how they work, and why, when used correctly, they add depth to an investor’s portfolio.
Also, they stress that structured products serve an even greater purpose. Everyday customers can benefit from structured products (like CDOs) that allow pooling of debt. In this way, structured products not only help investors, but also the general public.
Even still, structured products remain a mystery to most Americans. To get a better understanding, we have to separate fact from fiction.
How Structured Products Help Everyday Americans
Nowadays, many Americans have a visceral reaction to certain acronyms: ABS, MBS, CDO, CLO. Once upon a time, these never used to mean anything to people outside of the financial world
But it’s important to keep in mind that it’s not just banks that benefit from structured products. At the time of the crisis, for instance, Americans were leveraging the lower rates (much lower than they would have otherwise paid) offered by banks to take on the underlying loans, mortgages, and credit card debt.
Structured products work on the principle that the cash flow depends on the performance of underlying assets. By definition, a structured product is any product that derives its value from an underlying asset.
What does this mean? In essence, structured products are like traditional option pricing methods. They start to get complicated is when we start talking about derivatives. These include swaps, forwards and futures, and other embedded features like downside buffers and leveraged upside participation.
This works for both the financial institution and the customer. Thanks to structured packages, banks had the ability to package and sell consumer and homeowner debt, among other things.
The world has certainly learned many lessons about the risks of structured products, and those risks shouldn’t be taken lightly. But we must not forget that “structured product” encapsulates a huge range of varying products. They can give an investor customized exposure to assets that they might otherwise not have been able to access.
The risks are also better understood and managed now. In 2008, when certain companies became insolvent, many investors were caught off guard. They weren’t aware of the risks because they didn’t have the necessary information upfront.
Financial Benefits for Investors
Following the financial crisis, investors have been very pessimistic about structured products, believing there’s not much in it for them. Negative media has only exacerbated the situation. However, structured products have proven that when placed in the right hands, they can optimize the investor’s portfolios in numerous ways.
Structured investments can help investors tap into markets or asset classes they’d have otherwise not been able to access. Because structured products have predefined returns, we’re able to participate in emerging or overseas markets while shielding from risks. The variety of choice also offers flexibility to diversify the portfolio.
By nature, structured products are able to offer some form of capital protection, depending on the anticipated amount of return. Investors are typically able to protect their initial investment from any market downsides while still being exposed to upside potential.
A great example to this would be Structured Notes, which allow investors to commit their money for a certain term. As long as they hold the product to term, they’re guaranteed to retrieve their principal investment, provided that no default occurs. In addition to the principal, they will carry any upside movement of the value of the underlying asset.
Following full disclosure of underlying risks, investors know the full scope of potential risks that come with a structured note even before they throw in any investment. Thus, they can be prepared in terms of wealth management and planning for tax cuts.
The Future of Structured Debt: A Safer, Stronger Comeback
Initially, securitization was part of the problem. But that doesn’t mean it can’t be or hasn’t been part of the solution. *For instance, the Federal National Mortgage Association (FNMA), which is a Mortgage-Backed Security (MBS) is currently valued at approximately $100.*
Several years later, we can look back at the financial crisis with fresh eyes. That also means being in a better place to analyze the benefits and drawbacks of structured products. Now, we have to be sure to take advantage of the benefits while buffering against the risks.
Every two years, Ernst & Young’s (EY) Hedge Fund Journal names 50 allocators, brokers, advisors, and advisors as their “Tomorrow’s Titans”. The journal spotlights the industry’s champions of the new and dynamic in the hedge fund space. Those named in the prestigious collective have not been featured in past installments of the four-year old journal, and are nominated by peers, competitors, and a cross section of managers in the industry. These Titan nominators are important in that they help EY shine a light on rising stars who have been quietly building their impressive CVs in the background.
With EY’s commitment to helping and promoting hedge fund growth opportunities for managers, this list of fifty Titans are being lauded for providing innovation into the finance industry. The Tomorrow’s Titans are selected from across the globe of which 43 of 50 set up their own management companies and 7 were intrapreneurs who helped grow exponentially within already existing companies. 1 of the 50 named as Tomorrow’s Titan is Mr. T. Troy Dixon of Hollis Park Partners LP New York.
Mr. Dixon founded Hollis Park to pay homage to the Queens neighborhood where he grew up to remind him of his past, present, and no doubt bright future – made clear by this nomination.
Aside from being honored as one of the 2016 “Tomorrow’s Titans”, Mr. Dixon has previously been awarded Investment Dealers Digest’s “Top 40 under 40”, Institutional Investor’s “2015 Hedge Fund Rising Stars”, as well one of “Most Powerful Players Under 40” by Investor Dealer’s Digest. And going into 2017, there is no doubt T. Troy Dixon will likely receive more accolades in the upcoming year.
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.
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.
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.
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.