LONDON, 5 April 2004 — Over the past 20 years the hedge funds industry has developed from a disconnected and almost imperceptible assembly of individual investment entities into a highly sophisticated asset class with close to $1 trillion in assets under management.
Hedge funds — loosely-regulated private partnerships that bet on stocks, currencies and bonds and use leverage to boost returns — have been a key swing factor in financial markets, dictating direction.
“The evolution of hedge funds industry and strong demand from investors seeking to gain access to these innovative investment vehicles has resulted in European governments opening markets further to alternative investments. New money is pouring into hedge funds at an unprecedented rate and a growing audience of investors are coming to recognize the value of these unique and fascinating financial products,” said Stanley Fink, chief executive officer of Man Group PLC, during a workshop on hedge funds here last week.
“This shift into the mainstream has not been without its difficulties. Like any emerging industry hedge funds have endured scandal and high-profile failures, the most infamous being LTCM (Long-Term Capital Management), but these mishaps proved to be the spur for better management and risk control. As a result, the industry appears to be in good shape and set to continue its impressive expansion,” he said.
That expansion took off in the late 1990s as the potential for high earnings and the scope for freedom of action encouraged large numbers of entrepreneurial traders and investment managers to found hedge fund management groups. After a brief pause for breath in late 2002 and early 2003, the hedge fund industry has regained its rapid pace of expansion.
Fink said, “There are now almost 10 times more funds than there were in the early 1990s, and assets under management have expanded more than 15-fold.”
The long bull market, and subsequent bear market, favored equity hedge funds that captured some of the broad equity market gains in the good times, and — by and large — did a reasonable job of defending profits in the bad times. As a result, while global macro hedge funds dominated the landscape in 1990, funds implementing equity hedge style investment approaches are the most prominent today.
“However, if equity markets traded sideways for the next five to ten years, it is likely that more hedge funds would focus on arbitrage opportunities, while managed futures and global macro strategies would continue to enjoy fairly widespread popularity due to their low or negative correlation to equity markets and other hedge fund styles,” Fink said.
The rapid growth in hedge fund assets has raised capacity issues, though these have been offset by a long-term expansion in financial markets. The total capitalization of world stock exchanges currently hovers around $30 trillion. US fixed income markets alone stand at about $21 trillion.
Fink said this growth is also responsible for an influx of new talent and trading styles. “The team responsible for the identification of new investment talent at Man Investments has reported a greater variety and quality of hedge fund talent than ever before. With the various strategy groups, there is a wider variety of sub-styles than ever before. There are new managers with a real edge in their style, and there are completely new investment strategies emerging,” he said.
He added that “the expansion of derivative products further supports the evolution of the hedge fund industry, providing new possibilities. Firstly, derivatives permit parties to manage risks more efficiently and provide greater liquidity to capital markets. Secondly, the creation and permutation of derivative products, from the basic to the complex, provide additional means of investors such as hedge funds to develop innovative strategies or enrich existing strategies.”
The hedge fund industry has clearly come of age. The recent bear market provided a reminder to many investors that the rewards offered by traditional equities are a risk-premium and made the case for including alternative investment products that can offer strong risk-adjusted returns in all market conditions. That in turn has triggered the recent strong demand for hedge funds and is attracting large interest from traditional financial services looking to expand their product offerings.
Fink said, “The future of the hedge fund industry, therefore, lies in the hands of managers who are flexible enough to adapt to this changing landscape and have the intellectual and financial capital to develop new markets, source new capital and continuously evolve.”
