For the year to the end of July 2014, North American hedge funds outperformed their European counterparts and attracted more flows. The HFRI North America Index posted returns of 3.34% for the year to the end of July, compared to a loss of 0.46% for European funds.
Figures from Eurekahedge show European hedge funds gained roughly $33bn in net flows and recorded performance-based growth of $5bn. By comparison, North American hedge funds saw net flows of $35bn and achieved performance-based growth of around $27.5bn.
With less access to the capacity available at US hedge funds, European investors will increasingly have to compete for allocations to the best AIFMD-authorised hedge funds. This could result in significant unintended consequences.
“People are already talking about capacity constraints again,” Sussex Partners’ Ghali reports. “Good UCITS funds are opening and then closing again very quickly. With US managers increasingly able to raise sufficient capital at home, especially among the best managers, and more and more European managers opening US offices, the capacity available to European investors will reduce further.”
UNINTENDED CONSEQUENCES
European hedge fund launches were already significantly down by the end of Q1 2014, compared to 2013. Figures from Hedge Fund Research (HFR) showed European- located hedge fund launches declined as a percentage of total global launches from around 55% in 2013 to around 42% by the end of March this year.
Meanwhile, demand from investors has been on the increase. Preqin found 92% of the hedge fund investors they polled expect to either increase or maintain their current allocations to the asset class this year, with 95% expecting to do so over the longer term. With investor satisfaction with hedge funds reaching record levels in 2013, according to Preqin, the outlook for demand remains strong.
If the available capacity becomes constrained as demand increases, AIFMD will have the unintended consequence of tipping the supply/demand mechanics significantly in favour of managers, to the potential detriment of European investors.
Since the financial crisis, dissatisfaction with hedge funds enabled investors to apply considerable pressure on both fees and liquidity terms. If market dynamics shift back in favour of managers, creating a captive pool of investors, the trend will halt if not reverse. This is especially acute given research from BNY Mellon showing 92% of managers they polled expect total expense ratios to increase as a result of AIFMD. Preqin research shows fees continue to be the principal issue for many hedge fund investors.
Some improvements have been made, with 59% and 47% of investors noting improvements in management and performance fees respectively. However, 45% and 43% of investors want to see further improvements on management and performance fees respectively. HFR figures put average management and performance fees across the hedge fund industry at 1.52% and 17.99% respectively.
“There is likely to be a period of consolidation where hedge funds’ fees are concerned,” Omni’s Rodford believes.
“AIFMD compliant managers will have less competition in Europe and at the same time face increased expenses, which should keep fees at their current levels for longer.”
The other unintended consequence of AIFMD on European investors will be to create a big divide between large, well resourced investors and those who are more over-stretched. If investors are no longer able to rely on cap intro teams, proactively seeking out good US managers will become a much more resource- intensive task. This will make direct investment, as the UK institutional representative put it: “the privilege of only the largest funds.”
Ironically, for the majority of European investors, one result of AIFMD could be to reverse the trend towards direct investment by increasing investors’ reliance on funds of funds and other advisers, who are easily able to operate within the reverse solicitation restrictions.
As Omni’s Rodford says: “The consequences of AIFMD are highly frustrating for sophisticated European institutions, who rely on hedge funds as an important diversification element. They are already overstretched and this Directive will push them back into the arms of advisers and fund of funds.
“Investors may perversely end up paying more if they revert to a more intermediated model as European hedge fund capacity becomes increasingly constrained,” he concludes.
Comments