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Alternative asset class growth is unsustainable, says study

March 17, 2006 at 6:58 am

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The majority of third party marketers feel the alternative asset class industry has grown at a pace that is unsustainable, according to a n

The majority of third party marketers feel the alternative asset class industry has grown at a pace that is unsustainable, according to a new survey by Carbon360.

The study by Jackie Mandel, entitled 'Capital Introduction Trends in 2006', found that there is a growing consensus among third party marketers that many funds will not be able to survive and the result will be a tremendous amount of consolidation within the industry.

The majority of survey respondents are also expecting increased oversight of all hedge funds, broker-dealers and marketing firms, and that third party marketing firms who are not NASD broker-dealers will be required to register and comply with securities laws. Additionally, more SEC regulation of broker-dealers who perform Capital Introduction is also expected.

As a result of funds coming under stricter SEC guideline, the majority of respondents also expect more stringent due diligence to be done down the line from the third party marketer to the Prime Broker and to the investor.

In addition, funds of funds are expected to see redemptions as institutions, high net worth individuals and pension funds look to invest directly in hedge funds as a way of reducing fees.

The other main findings of the survey are as follows:

In addition to traditional long/short funds, investors are very interested in more industry/sector specific strategies:

67% US Equity L/S
47% Emerging Markets
47% other: This includes: Multi-Strategy, Event drive/Merger Arbitrage, Asset Backed lending and Japan and India focused strategies.
33% Global Marco
7% Fund of Funds/CTA/FX and Distressed

Survey results confirmed that the changing landscape of the investor base is now dominated overwhelmingly by institutions:

94% Institutions
31% High Net worth Individuals
7% Family offices/Pension Funds

As might be expected, third party marketers mainly source their investors in the US and Europe, but are increasingly looking to Asia and Australia as
sources of new capital allocation as hedge funds grow in these regions.

80% US
50% Europe
19% Pacific-Rim
7% Australia

While it is no surprise performance drives investor decisions it is curious that in light of recent hedge fund blowup's more investors are not as concerned with the infrastructure of the fund they are investing in:

100% Performance
56% Reputation
31% Infrastructure/Transparency/Risk Management/Consistency in the application of the process.
19% Preservation of Capital

Third party marketers appear to have the most traction with relatively newer funds:

94% Managers with a track record less than five years.
69% New Managers/Startup's.
62% Emerging Managers with a track record less than one year.
62% Managers with a track record greater than five years.
6% Fund that deal with top level providers - (i.e.) Auditors, Lawyers, Administrators, Prime Brokers.

Although fee structures appear to be standard based on a supply/demand model it is important to note they can be customized depending on the manager. Therefore the survey results do not reflect 100% participation to this question.

Managers with a track record of less than five years:

64% charge 20% of management and incentive fees.
9% charge 20-25% of management and incentive fees as long as capital is invested.
9% charge 25% of management and incentive fees.
9% work on a retainer basis

Emerging mangers:

60% charge 20% of management and incentive fees
20% work on retainer, commission and performance based fee
10% charge 20-25% of management and incentive fees as long as capital is invested.

Managers with a track record greater than five years:

64% charge 20% of management and incentive fees.
9% charge 20-25% of management and incentive fees as long as capital is invested.
9% charge 25% of management and incentive fees.
9% work on a retainer basis

New Manager:

43% charge 20% of management and incentive fees.
28% work on retainer, commission and performance based fee.
9% charge 1.5% of the management and 20% of the incentive fee.
9% charge 25% of management and incentive fees.

In an effort to source potential managers and investors, third party marketers work with 'advisors' who have industry knowledge:

100% find managers through referrals
25% from cold calling.
12% from networking.

When third party marketers are sourcing potential investors:

87% find investors through referrals
60% from cold calling.
47% from experience/long term relationships/networking or advertising.

As might be expected, background due diligence is of paramount concern to third party marketers as operational and process due diligence take a back seat.

100% conduct background due diligence
81% conduct operational and compliance due diligence
13% conduct process and performance reviews.

When it comes to conducting due diligence:

100% conduct on-site visits to the manager, with some conducting quantitative, accounting, middle and back office analysis.
75% work on a referral basic
69% conduct a literature/public records search
56% utilize contracted research

Background notes: CarbonBased Consulting (Carbon) together with Carbon360 Research (Carbon360) is an established research and advisory firm focused exclusively on the asset management industry. Founded in 1997, with offices in New York City and Greenwich, CT, Carbon's line of research services include: up-to-date; in-depth product guides; vendor profiles and comparisons; user surveys highlighting industry trends; qualitative and quantitative market research; and interactive, self-executing management evaluation and management tools.

Jackie Mandel is a senior business consultant with CarbonBased Consulting and Carbon360, with 20 years of hedge fund and investment banking experience. She was a Vice President at Goldman Sachs in the Equity Derivates Group for seven and a half years prior to joining CarbonBased. Prior to that Mandel was a trader at Tiger Management for four years and she has also head positions at Lehman Brothers and The Millburn Corporation. Mandel has a BA from SUNY at Stony Brook. In addition she has her series 3, 7 and 63 certification.