Is 2014 the year for a return to hedge funds?

2014 is in full swing and with it comes a new round of regulations being imposed upon the hedge fund industry. Life for a hedge fund manager is no longer an easy environment to operate in; fund managers are having more and more to divert attention away from managing money to all the slew of compliance and reporting under the new regulations.

It is an unfair situation as fund managers should be concentrating on what they are best at – managing money. Diverting attention can impact upon performance and this is not in the interest of investors.

Are all the new regulations and reporting requirements necessary?

Yes and no. Much of it stems from governmental paranoia concerning systemic risk to economies. But frankly, as proved in 2008, systemic risk lay within the banking industry, not the hedge fund industry. In 2003 in a paper prepared by AIMA in South Africa for the South African Minister of Finance it was pointed out that is where the danger lay. However, this was disregarded as he subscribed to the International Finance club of hedge fund witch hunters. Luckily South African hedge fund managers were protected from most of the 2008 fallout because of little exposure to international events.

Regulating the industry to ensure more transparency is possibly a good thing and in the interests of hedge funds who are seeking serious money. The investing clientele has changed. No longer are they mainly high-net-worth individuals, the money is increasingly coming from institutions such as pension funds with more stringent oversight.  With that comes new responsibility to investors. This is hard-earned savings from the man in street. Therefore greater transparency and risk management is required. But it is good client money, trustees take a long time to decide to invest, but they also do not disinvest at a drop of a hat.

But there is a huge danger of over-regulation. AIFMD is an over-kill involving what for years we have called building the “walls of Fortress Europe”. AML is also over the top and parties such as banks in the business chain of a hedge fund seem not to understand where the responsibilities lie. Opening and managing investment accounts is increasingly a nightmare of red tape.

The rise of the importance of Compliance is the creation of a breed of Gestapo-like monsters wielding obnoxious arbitrary power. There is no consistency in requirements between institutions, which leads one to believe that the rules are not understood by Compliance officers who arbitrarily impose their own interpretation and rules.

The means that high barriers of entry are being erected, forcing fund managers to remain in institutions and therefore institutionalise hedge funds.  Investors are confusing size with protection. That is an oxymoron; large institutions often create market inefficiencies and can create systemic risk. Clearly authorities and investors have not learnt the lesson of 2008 and the issue of “too big to fail”!

My “lofty” mission is to provide assistance to emerging new managers. Emerging new managers are hopefully the investment houses of tomorrow and they need to be helped to get on to the ladder. Anticipating all these rules and distractions I have set up structures and providing services that take into account many of the new requirements.  Fund managers have a choice of Cayman or Malta (EU). But managers need to understand there is no “holy grail”, which is a fund that can take US investors, EU investors and the rest of the world.  Countries are bent on ensuring that they get their tax cut on their citizens (and others if they have a chance), so different fund structures need to be established to avoid the conflicts.

Managers of diversified client portfolios are at present “reluctant bulls” in the long market. Hedge funds were overshadowed by equities in 2013, but now that there is a dearth of cheap stocks and fixed income still looks unattractive, it should be the time for investors to start including hedge funds in portfolios. The current low-yield environment, with equity market rallies over the past few years, argues strongly for adding a source of uncorrelated returns to a diversified portfolio.

Is 2014 going to be the year of the return of investors to hedge funds?

Ian Hamilton is the founder of IDS Group, which provides fund administration services in Africa and Europe through Malta. He is also the founder of Scotstone Investments, a company that has fund structures and services for global emerging new managers. The views expressed in this column are his own.

This article was first published in Opalesque’s New Managers monthly publication