BNY Mellon and Greenwich Associates, a financial services consulting firm, have published a study that examines the current and projected future state of convergence between traditional long-only investment managers and hedge fund managers.
The study, ‘Breaking Down the Walls’, draws on 71 interviews with traditional investment managers, hedge funds and institutional investors. It concludes that, despite having accelerated in the wake of the financial crisis, convergence between traditional asset managers and hedge fund managers remains an emerging trend. While investors perceive several advantages in traditional managers running hedge-like strategies, they recognise that hedge funds maintain certain competitive advantages in managing long-only strategies.
Key findings include:
- Despite years of industry deliberation, convergence remains an emerging trend. Fifty-two percent of hedge funds and 46% of traditional investment managers participating in the study report taking some steps in the direction of convergence. However, only a very small number of investors currently use hedge fund managers for non-hedge strategies or traditional managers for hedge fund-like strategies.
- Managers do not universally acknowledge convergence as a trend. Some managers have offered cross-over products for more than a decade. Additionally, most hedge funds see changes they are making to their products and policies not as part of an attempt to ‘converge’, but rather as a natural progression of their own business and investment models, which allows them the flexibility to adopt whatever approaches have the best chance of meeting client needs and delivering strong investment results.
- Traditional and hedge fund managers alike underestimate the challenge at hand. The majority of investors emphatically state that they would not be receptive to using hedge fund managers for non-hedge strategies or traditional managers for hedge fund-like strategies. Convergence success will require managers to develop new distribution capabilities, provide greater transparency, revise fee structures, and polish messaging about topics such as alpha and risk.
- The use of external service providers is on the rise. Approximately one quarter of participating managers say their efforts at convergence generate a heightened need for better integration of front, middle and back office functions. About one third of managers currently outsource components of their back office. As fund managers seek to compete beyond their historical footprint, new capabilities are required and leveraging external service providers will play an increasingly pivotal role in their success.
- The trend towards convergence is compounding pressure on fees at some hedge funds. Hedge funds with strong investment performance still command traditional fee levels, while funds with uneven performance are feeling pressure to lower fees.
- Perceptions regarding the likely impact of regulation depend upon your vantage point. Traditional managers and hedge fund managers are considerably less likely than institutional investors to believe that there are regulations on the horizon that will impact the trend towards convergence.
Jim Palermo, co-chief executive officer (CEO) at BNY Mellon Asset Servicing, said: “Changes to hedge fund structures and policies are beginning to erode some of the historic distinctions between hedge and long-only funds. The most important and obvious example of this trend is the move by hedge fund managers to provide investors with enhanced levels of transparency and broader disclosure. In the post-crisis environment, hedge fund managers find themselves responding to their clients’ demands for transparency down to the portfolio holdings level as part of new risk management efforts.”
Andrew McCollum at Greenwich Associates said: “The results suggest that managers of all types should remain open-minded to best practices from across the industry. Hedge fund managers should be looking to emulate the strengths of traditional managers, including their powerful brands and transparent processes. Traditional managers, meanwhile, should be looking to build up and demonstrate the capabilities in hedge strategies and to increase their ability to react quickly to market changes and opportunities.”