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Hedge fund managers: Start thinking like a mutual fund

The hedge fund industry has evolved from its heady beginnings, when a few elite managers went unquestioned as long as they delivered superior returns. Today, hedge fund managers should match the transparency and service offerings of mutual funds to meet the expectations of their broadening investment base.

Competition in the alternative investment space has increased, with more and more managers plying hedge fund strategies for investors who are willing to accept increased risk for enhanced alpha. The industry has grown and matured, and with that growth comes demands for increased transparency and service.

Investors are no longer happy with the returns offered by traditional long-only strategies, and they are turning toward alternative investments for results. This trend benefits hedge funds as they have a broader market to serve and draw investors from, but democratization has also led to more demands on transparency, fee structure, communication with investors and new products.

Hedge fund managers must start thinking like mutual funds to meet these demands and better serve their clients.

Better transparency

One of the most common investor demands is for more readily available data. The type of data hedge fund investors want is typically generated from the back-end system. BNY Mellon presents such data on demand through a web-based portal.

This is a customisable and easy-to-use platform that allows managers to enhance their own client experience and improve operating efficiency through increased digitization and transparency of their work flows.

While enhancing access to data improves transparency, there is a limit to how much information hedge fund managers are willing to share. Few, if any, are willing to offer transparency on their short positions, as doing so could threaten their access to the companies whose shares they trade. However, we do see a growing trend where managers are improving their level of transparency, which may involve offering country- or sector-based data on their short positions.

Lower fees

We are witnessing a decline in fees amongst hedge fund managers, but it has yet to become a wholesale drop. With the world's biggest mutual fund companies advertising zero-fee funds, the hedge fund industry must prepare to cut their own fees as well. Clients are no longer willing to accept fees without a challenge in exchange for higher returns.

The typical 'two and 20' compensation structure is under threat. The new trend is generally towards 1.5% of assets and 15% of profits, led by start-ups keen to win market share. While established funds with solid performance records may be able to charge premiums for a bit longer, they need to be aware that they are being undercut, and that the competition is nipping at their heels.

Greater efficiency

If managers are to lower their fees, they must lower their costs. Adopting more technology is one way to achieve this. However, technology is expensive, and today's tighter profit margins may prevent a small hedge fund manager from investing in new platforms. The solution is for managers to make use of the technology infrastructure of their fund service providers. Technology used by a service provider can potentially help a manager save costs and improve their client experience.

Data dissemination is a major cost for managers, but it can also create competitive advantages. Many investors request intra-day access to their fund data, putting pressure on managers to improve their systems.

This is a challenge that can be addressed by capitalizing on a fund service provider's technology platform. The industry has increasingly demanded service providers to offer proprietary data portals or raw data feeds that managers can then integrate into their own platforms for a more customized experience.

The hedge fund industry is growing and evolving to become more service orientated while still providing returns that are above those of the mainstream investment management industry.

There is a clear trend towards more transparency, lower fees and more efficient operating models. Hedge funds must start thinking more like mutual funds to remain competitive in this changing industry.

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