Several significant challenges confront the industry as 2014 draws its last breaths, not the least of which is the trend away from traditional 2 and 20 fee structures.
Fee Structures
No single event brought this into clearer focus than the CalPERS’ $4 billion redemption in hedge fund investments announced earlier this year. CalPERS cited high fees and disproportionate performance as factors contributing to the decision.
Two and twenty has been under relentless attack for some time. As a practical matter, management and performance fees are looking more like 1.5 and 18. Next year will likely determine whether management and performance fees will continue their slide or be augmented by hurdle structures rather than the customary high water mark prevalent in the industry.
Cyber Security
Incredibly, hedge funds have yet to experience significant, well-publicized hacks. However hacks have occurred, specifically, the disruption of one firm’s high speed trading platform, as reported by Bloomberg in June, 2014. The same report alleges other incidents. Hedge funds are less than transparent, so the fact that hedge fund hacks have not been well-publicized falls short of proving that they are not occurring.
In April, 2014 the SEC elevated the threat risk posed cyber attacks and announced that their office of Compliance Inspections and Examinations would focus on cyber security preparedness. Initially, this will manifest iteslf in the form of a questionnaire. One significant question on the list asks whether or not the firm employes a Chief Information Security Officer (CISO). This question reveals more than it asks and forward-thinking hedge fund managers will act accordingly.
Data Management and Reporting
Much discussion centers on the pressing issue of data management and its juxtaposition with reporting requirements. The complexity of reporting is straining the limits of current methodologies. Traditional hedge fund operating models are simply inadequate to effectively manage the wealth of data available. New models must be employed to leverage this data and employ it, not only for reporting purposes, but also to enhance the fund’s ability to execute. Stakeholders require faster access to pertinent information. Hedge fund managers must position their firms with state of the art systems to manage and control strategies—and, to retain their competitive edge.
Regulatory Concerns
New requirements for repository reporting, portfolio reconciliation and FATCA-like regulations are but the tip of the iceberg. The SEC is grinding out new regulations and redefining old ones (qualified investor, for example) at a furious rate. Navigating this spider’s web will be one of the most difficult challenges confronting hedge funds in 2015 … and beyond. Too many regulations are in a state of flux, making these waters extremely problematic.
So, in many ways, 2015 is a “rinse and repeat” of 2014 but hedge fund managers will need to up their game to meet the challenges offered in the coming year. Fees, data management, cyber security and regulations comprise the short list but, make no mistake; the list of issues facing hedge fund managers is much longer.
