The hedge fund industry is transforming, with managers increasingly focused on customized products and solutions, new investors, and emerging markets.  This is the conclusion of "Growing Up:  The new environment for Hedge Funds," the new report produced by KPMG International, the Managed Funds Association (MFA), and the Alternative Investment Management Association (AIMA).

The report is based on global research, with more than 100 hedge fund managers representing approximately USD440 billion of assets under management.  Their views reflect fundamental shifts occurring in the hedge fund industry; key findings include:

• A majority of hedge fund managers expect a significant shift in their primary sources of capital to pension funds over the next five years; 
• Almost 70 percent of managers said they offer, or plan to offer, custom investment solutions; 
• More than two-thirds of managers anticipate using specialized fee structures to attract investment; 
• More than four in 10 managers expect to change the mix of countries where they invest, with more than a third targeting emerging and frontier markets; and 
• Regulation is seen as the biggest threat to the growth of the hedge fund industry, as cited by more than three-quarters of managers.

"Our survey shows the transformative change that is impacting every aspect of hedge fund management, from product mixes and fee structures through to markets and investor types," said Robert Mirsky, Global Head of Hedge Funds, KPMG International. "The managers we spoke to around the world recognize that the industry must continue to adapt and adjust strategies in order to thrive." 

Shift to Institutional Investors

The report finds further evidence that the growth of the hedge fund industry is being driven today largely by institutional investors rather than individuals.  A majority of managers expect a significant shift in their primary sources of capital, with most saying that pension funds – both corporate and public – would be their primary sources of capital by 2020.

Forty-six percent of managers said that over the next five years they would either alter their fund strategy or launch new products to attract capital from pension funds.

"The days of hedge funds simply being an investment tool for high-net worth individuals are over," said MFA President and CEO Richard H. Baker. "Institutional investors like pension plans, university endowments, and charitable organizations now make up nearly 65 percent of the industry's assets. These diverse partnerships help local economies and underscore the important role alternatives play at both the macro and micro levels." 

New Strategies Highlight Customization, New Markets

Nearly two-thirds of managers said there is increased demand for custom solutions from their investors.  In fact, almost half said they already offer a 'fund of one' or managed fund solution with an additional 21 percent saying they intend to offer these solutions within the next five years.  

With custom solutions come more customized fee structures. More than two-thirds of managers say they anticipate using specialized fee structures as a means of attracting investment.  

"The global hedge fund industry, which has grown by more than 10 percent a year since the financial crisis, is well-positioned to maintain this growth trajectory over the next five years," noted Jack Inglis, CEO, Alternative Investment Management Association.  "The research shows that, as the industry continues to evolve and mature, a combination of institutionalisation and customisation will effect positive change and encourage ever greater allocations from pensions and other institutional investors."

Geographically, most capital invested in hedge funds still comes from North America and Europe, but the research suggests that the greatest percentage increases in inflows are coming from Asia Pacific, the Middle East and Africa.  More than four in ten managers expect to change the markets where they invest – with more than a third of those targeting emerging and frontier markets.  

Limiting Factors to Industry Expansion

Increased cost and complexity associated with running a hedge fund management firm will limit growth of the industry over the next five years, according to the research, with more than three-quarters saying the number of hedge fund managers will decrease or stay the same.

Regulation, cited by more than three-quarters of managers, is seen as the biggest threat to growth of the hedge fund industry. 

This is particularly the case in Europe and Asia Pacific, where more than 80 percent of managers cite regulation as the biggest threat to growth, while in North America it was cited by 67 percent.

"The research confirms what KPMG professionals see with clients, with a much greater focus on compliance," said Tom Brown, Global Head of Investment Management, KPMG International.  "But the good news is that while compliance obligations have increased operating costs, there are signs that these costs are flattening out and fund managers can put more of their attention on growth."