FEATURE: Hedge funds the characteristics of success

The adaptability of the hedge fund industry is one of its key strengths and in a world of increased regulation, empowered investors and global choice, the successful hedge fund manager needs to sustain this track record of innovation to meet the needs of tomorrow’s clients

Hedge funds have existed in a number of different forms for much of the past 100 years, although they have gained significant popularity in the 21st century. In South Africa, hedge funds – accessed through word of mouth and private arrangements – have previously been unregulated and the sector remains small, with assets under management at less than 5% of those invested in more traditional collective investment schemes.

This has changed in recent years with the introduction of Board Notice 52, which came into effect in 2015, introducing regulations governing, inter alia, hedge fund operations, marketing and investor protection. there are now two types of regulated hedge funds: retail investor hedge funds (RIHFs) and qualified investor hedge funds (QIHFs), allowing hedge fund managers to access a much wider investor base.

While investment performance is clearly essential for the success of a hedge fund and growth in assets under management, the rapidly evolving demands of a sophisticated investor population are making it increasingly difficult for performance to shelter any shortcomings in other areas – particularly over the long term.

To look at how hedge funds address this challenge, EY, together with the Alternative Investment Management Association (AIMA), recently published a research report, ‘Traits of success: What hedge fund managers think it takes to succeed’, aimed at identifying the characteristics and behaviours that contribute to successful hedge funds. The report found that although hedge fund managers have different opinions of what success means, it was quite clear that they all share similar views on what ultimately drives their success.

Managing people and culture

A strong and distinctive culture is increasingly important to the success and longevity of a firm, as well as adaptable leadership and the right blend of people. In the report, one of the managers interviewed describes culture as something that needs to live and breathe and come from the top, as the firm grows and augments over time. Recruiting the right staff is therefore seen as vital for any hedge fund and some managers even admit to putting job candidates through up to 10 stages of interviews. Once on board, the challenge then lies in retaining the right people as low employee turnover speaks about the stability of the manager’s operations. That being said, while employee turnover can play a key role in investor confidence, its impact will depend on the seniority or specific expertise held by a given individual, and in some cases a degree of turnover can be seen as helpful in maintaining the high performance of an investment team.

Unsurprisingly, there is widespread consensus that underperforming employees can be damaging to culture, reputation and performance, and cannot be ignored. However many managers see disruptive employee personalities in their firm as a greater threat. Clearly even the most talented individuals, if disruptive, have the potential to damage the culture of the firm if not dealt with immediately.

Managing the infrastructure

Continuously improving investment performance remains pivotal to any hedge fund, but a firm’s operational infrastructure is a core enabler of success. In today’s regulatory climate, a firm’s operational credibility could make or break it and managers confirm that there is little to no tolerance for hedge fund firms that try to operate without a robust operational framework in place.

In South Africa, the typical hedge fund manager outsources the majority of back office functions. This allows managers to focus on and prioritise ‘core’ activities and is scalable – allowing the managers to grow without the need to reinvent back office systems and processes. However, it is imperative that appropriate supervision of outsourced activities be maintained and that responsibilities and reporting lines be clearly defined. At the end of the day, responsibility for managing the risks associated with outsourcing remains that of the manager.

Managing investor relationships

Investment managers should not underestimate the value of communication and transparency in delivering excellent client service. Setting realistic expectations upfront, without over-promising, is the foundation of a sound relationship between investor and fund manager. At times this will mean delivering bad news, but consistency is seen as crucial, and reassuring the fund’s existing investors is just as important as attracting them. One manager we interviewed pointed out that very few people get into trouble for over-communicating, but many get into trouble for under-communicating.

Perhaps counter-intuitively, successful hedge fund managers also find value in conducting due diligence on investors and not just the other way around. Choosing an investor is essential in ensuring that hedge fund managers and investors share common goals and that their interests are aligned, consistency of objectives makes for a more productive and long-lived relationship.

While success means different things to different firms, depending on lifecycle stages, strategies and chosen markets, it is clear that hedge fund managers see a similar range of factors as crucial to their success. Many of these factors are interlinked, for example firms with the right culture have an easier time recruiting the right people, helping them give the investors the right experience.

Visit https://go.ey.com/2kBmUfs to read the full report

AUTHORS: Anthony Cadman, Africa Hedge Fund Services leader at EY with Nailah Limbada and Izaan van As, Africa Hedge Fund Services specialists at EY

NOTE

This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisers for specific advice.

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