FINANCIAL MARKETS SERIES HEDGE FUNDS

Transcription

1 FINANCIAL MARKETS SERIES HEDGE FUNDS MAY 3

2 TheCityUK champions the international competitiveness of the financial and professional services industry. Created in, we support the whole of the sector, promoting UK financial and professional services at home and overseas and playing an active role in the regulatory and trade policy debate. TheCityUK has a global export focus with a commitment to help UK based firms grow their business in other parts of the world. In, the financial services industry accounted for 9% of UK GDP and % of UK tax receipts. The sector currently employs over one million people, more than 66% of whom work outside London, and underpins the businesses that drive jobs and growth. Added together with nearly one million employed in professional services, it is easy to see the importance of a sector that employs 7% of the working population. TheCityUK provides constructive advice and is the practitioner voice on trade policy and all aspects of taxation, regulation, and other legislative matters that affect the competitiveness of the sector. We conduct extensive research and run a national and international events programme to inform the debate. Our senior team regularly engages with regulators and policymakers at home and overseas, ensuring the sector s views are represented at the highest levels. We are tasked with creating a new vision for the financial services sector. We are focused on supporting policymakers and business to deliver the new policy ideas which will help deliver growth.

3 HEDGE FUNDS MAY 3 Hedge funds have faced a challenging financial environment in recent years. The economic slowdown, volatility in the markets, concerns over the sovereign debt situation in Europe and regulatory changes have contributed to a net asset outflow over the past five years. This report provides an overview of the global hedge funds industry with particular emphasis on London s role as the second largest global centre for management of hedge funds. The UK s share of global hedge fund assets totalled 8% in SUMMARY Assets under management of the global hedge funds industry totalled over $,bn at the end of (Chart ). The 6% increase during the year was driven by performance gains and follows a slight % reduction in the previous year. Industry assets are close to the 7 peak and have risen more than three-fold over the past decade. Funds under management increased by a further $7bn in the first quarter of 3 due both to positive returns and a net inflow of funds. Additional growth in 3 will largely be dependent on the recovery in global financial markets. The small net asset outflow seen during was more than offset by a 6.% performance return. This was only slightly below the average annual hedge fund return of 6.% seen over the past decade. Assets of fund of funds totalled $bn, or a around quarter of global hedge fund assets under management. This was down 4% on the previous year and more than 4% below the peak from 7. The number of hedge funds totalled,, with new hedge funds launches outpacing fund liquidations for the third successive year. Strong growth of UCITS-compliant hedge funds has suplemented the fund population in Europe. The UK is the dominant centre in this area and is the management location for nearly three quarters of UCITS-compliant hedge funds assets. Location of management The is the largest centre for hedge funds, managing close to 7% of global assets at the end of, down from 83% a decade earlier. Europe followed with % and Asia with most of the remainder. TheCityUK estimates that around 4% of global hedge fund assets were managed from New York, down from over a half a decade earlier. London s 8% share in was slightly down on the previous year, but nearly double its share ten years earlier. The breakdown of fund of hedge funds by manager location shows that a quarter of global fund of funds assets were managed from the UK. Estimates of the size of the industry vary due to restrictions imposed on advertising and reporting of performance by hedge funds. This report is based on commercial databases and index providers which rely on information provided voluntarily.

4 HEDGE FUNDS MAY 3 London remains by far the largest centre for hedge funds in Europe. Around 6 funds located in the UK managed some 8% of European based hedge funds assets. The largest seven hedge funds in Europe were all headquartered in London in. London retains its structural advantages which make it an attractive location including its local expertise, the proximity of clients and markets and a strong asset management industry. London is also a leading centre for hedge fund services providers such as administration, prime brokerage, custody and auditing. Accounting for around a half of European investment banking activity, it is a natural location for prime brokerage services. The UK hedge fund industry employs around 4, people. Around, of these are directly employed by hedge funds and the remainder among the industry s advisers and service providers. Chart 3 Net asset flow - annual $bn Net asset flow Performance based change Asia also has an important role in the global hedge fund industry, both as a location for management of funds and as a source of global hedge funds assets. Important centres for management of hedge funds in Asia include Hong Kong, Australia, Singapore and Japan Source: TheCityUK estimates Flow of funds Hedge funds saw a $7bn outflow of funds during. The net inflow seen in the first three quarters of the year was more than offset by a net outflow in the fourth quarter of $8bn. Concerns about the European debt crisis and slow global economic growth are continuing to constrain new investments. The net inflow in funds may resume in 3 as the global economy recovers and investors regain appetite for alternative investments. Regulation of hedge funds is being tightened in the wake of the financial crisis. In the, the focus is on changes in registration requirements and reporting of information for use in monitoring systemic financial risk. In Europe the focus is on implementing the Alternative Investment Fund Managers Directive (AIFMD), which is expected to be transposed into national law by July 3. The AIFMD includes provision for a transitional period, allowing AIFMs up to a year in which to seek the necessary variation of permission, authorisation or registration in their home member state. THE GLOBAL HEDGE FUNDS INDTRY Chart Management location of global hedge fund assets Assets under management of the global hedge funds industry totalled over $,bn at the end of (Chart ). The 6% increase during the year follows a slight % reduction in the previous year. Industry assets are close to the 7 peak and have risen more than three-fold over the past decade. The small net asset outflow seen during was more than offset by a 6.% performance return (Chart 3). Funds under management increased by a further $7bn in the first quarter of 3 due both to positive returns and a net inflow of funds. % share % 4% 3% Americas Europe Asia Other 3% 6% % Flow of funds Hedge funds saw a $7bn net outflow of funds during (Charts and 3). The combined $bn inflow seen in the first three quarters of the year was more then offset by a net outflow in the fourth quarter of $8bn. Prior to this, hedge funds saw a net inflow in funds during and of around $7bn in each year. Concerns about the European debt crisis and slow global economic growth are continuing to 8% 7% Source: TheCityUK estimates

5 HEDGE FUNDS MAY 3 constrain new investments. Hedge funds more oriented towards institutional investors have been faring better as these investors are less inclined to redeem assets. The net inflow in funds may resume in 3 as the global economy recovers and investors regain appetite for alternative investments. Number of hedge funds The number of hedge funds totalled around, at the end of with new hedge fund launches outpacing fund liquidations for the third year running (Chart 4). Strong growth of UCITS hedge funds has suplemented the fund population in Europe even at times when other regions saw a declining number of hedge funds. Three quarters of the global number of funds were single manager hedge funds and the remainder fund of hedge funds. Employment According to the Alternative Investment Management Association (AIMA), the UK hedge fund industry employs around 4, people. Around, of these are directly employed by hedge funds and the remainder among the industry s advisers and service providers. The global hedge fund industry employs some 3, people, with North America accounting for 8% of this figure, Europ e 7% and Asia for most of the remainder. Table Global absolute return UCITS funds Geographical distribution of hedge funds Location of management Hedge funds are predominantly managed from onshore locations. The is by far the leading location managing some 7% of global assets in. This was however below its 8% share at the start of the decade. Europe nearly doubled its share during this period (Chart ). New York is the world s leading centre for managers of hedge funds, followed by London. TheCityUK estimates that 4% of global hedge fund assets were managed from New York in, down from over % a decade earlier (Chart 6). London s 8% global share in was slightly down on the previous year but nearly double on its share a decade earlier. UK France Germany A Switzerland Luxembourg Singapore Sweden Hong Kong Italy Monaco Liechtenstein Norway Other Total No of funds Source: Hedgefund Intelligence % share Assets under management ($m) 8,63 4,76 6,8 3,,988,94,98,486, ,6 % share 74 London is much the largest centre in Europe for the management of hedge funds. At the end of, over two-thirds of European single manager hedge fund assets totalling $436bn were managed out of the UK, the vast majority from London (Chart 7). If fund of funds assets are taken into account, London probably accounts for around 8% of hedge funds assets managed in Europe. There were nearly, European-based hedge funds in, of which some two-thirds were located in London. The largest seven hedge funds in Europe were all headquartered in London. Other important locations for hedge fund 3

6 HEDGE FUNDS MAY 3 managers in Europe include the Channel Islands, Sweden, Switzerland and France. Many hedge funds in Europe have in recent years launched UCITS compliant stand-alone onshore fund vehicles which are allowed to be distributed throughout the EU to institutional and retail clients. These funds employ a range of strategies that use derivatives and limited leverage within a regulated framework. UCITS-compliant hedge funds in Europe have increased more quickly than non-ucits funds since 8, and accounted for over a third of European industry assets at the end of. UCITScompliant hedge funds offer greater liquidity to investors and lower leverage which has helped them to raise new funds. The UK is the dominant centre in this area and accounts for nearly three quarters of UCITS-compliant hedge funds assets (Table ). London retains its structural advantages which make it an attractive location for management of hedge funds. These include its local expertise, the proximity of clients and markets and a strong asset management industry. London is also a leading centre for hedge fund services providers such as administration, prime brokerage, custody and auditing. Accounting for around a half of European investment banking activity, it is a natural location for prime brokerage services. Chart 8 Global hedge fund returns %, return Source: Hennessee Hedge Fund Indices Chart 9 Strategic mandates by assets under management % share, Asia also has an important role in the global hedge fund industry, both as a location for management of funds and a source of global hedge funds assets. Important centres for management of hedge funds in Asia include Hong Kong, Australia, Singapore and Japan. Distressed debt Others Relative value 3% 4% Fixed income 6% 6% Arbitrage 8% 3% Long/short equities Domicile of funds Hedge funds can be domiciled in onshore or offshore locations. Around a half of the existing hedge funds are registered offshore and a half onshore. The Cayman Islands are the leading domicile for offshore funds, accounting for 34% of the total number of global hedge funds. The accounted for 4%, Luxembourg %, Ireland 7%, the British Virgin Islands 6% and Bermuda 3%. Due to the requirement for UCITS European hedge funds to have an onshore European domicile, most new hedge fund launches in Europe in and were domiciled in onshore locations, predominantly Luxembourg and Ireland. RETURNS AND INVESTMENT STRATEGIES Hedge funds returned on average 6.% in (Chart 8). This follows a loss of % in and gain of % in. Hedge funds of funds returned % during the year, following a 6% loss in. Some major domestic and international indexes have however outperformed hedge funds in, with for example the S&P index returning 6%. This was partially due to conservative positioning of hedge funds at the start of the year due to volatility in the markets in recent years. Funds investing in high-growth emerging markets such as Russia, Latin America, Asia and the Middle East typically produced the strongest returns in recent years. Hedge funds returns vary from year to year but overall hedge funds have seen an average return of 6.% during the past decade. Investment strategies of hedge funds vary enormously. Strategies may be designed to be directional (which try to anticipate market movements) or market-neutral (which have low correlation to the market movements). Macro CTA/managed futures 8% Source: Eurekahedge % % Event driven 6% Chart Global hedge funds by source of capital % share 8% 9% 8 % 6 4 4% 44% 8% 8% % 3% 4% % % % 3% 3% 9% 6% 4% 9% % Multi-strategy 9% % 6% 7% 3% 8% % % % % Individuals Fund of funds Pension funds Corporations & other Endowments and foundations Source: Hennessee Group LLC; FSA; TheCityUK estimates 4

7 HEDGE FUNDS MAY 3 Equity long/short strategies typically accounted for 3% of strategies, followed by multi-strategy and event driven funds (Chart 9). Relative value funds showed the highest return during the year with a % performance gain. They were followed by event driven strategies (7%) and equity hedge funds (6%). Macro strategies fared worst during the year. SOURCES OF FUNDS Institutional investors are the biggest source of capital for hedge funds and account for around a half of hedge funds assets under management. A breakdown of institutional investors by type of investor shows that in fund of hedge funds and corporations accounted for a quarter of total assets each, followed by pension funds % and endowments and foundations 8%. Individuals accounted for the remaining % (Chart ). The geographical breakdown of institutional investors shows that in recent years, more than a half originated in the, % in the UK and % in Switzerland. Institutional investor capital is likely to become more important to hedge funds in the coming years. Preqin data shows continued investor interest in hedge funds, with 6% of institutional investors surveyed looking to bolster their hedge fund allocations during 3. Long/short equity, macro and event-driven are the most sought after strategies. Some 6% of managers stated that delivering returns would be their biggest challenge in 3, followed by fundraising (48%) and regulation (4%). AIFMD, JOBS Act and Dodd-Frank were the three most significant pieces of regulation circulating, according to managers. Chart Single manager capital from fund of hedge funds % share, single manager hedge fund capital provided by funds of hedge funds Fund of hedge funds assets totalled $bn or a quarter of global hedge fund assets under management at the end of. This was down 4% on the previous year and more than 4% below the peak seen in 7 (Charts and ). The value of the industry s assets began to fall in mid- 8 as investors began converting their investments into cash due to widespread losses in the hedge funds industry and the reputational damage to the industry following the revealing of the Bernard Madoff fraud. The breakdown of fund of hedge funds by manager location shows that a quarter of assets were managed from the UK. The was the most popular location with 3% of the market. Switzerland and France were also important centres. The number of publicly quoted fund of funds has increased over the past decade. Most of these listings are on the London and Zurich exchanges. The London Stock Exchange overtook Zurich in 6 to become the location of choice for funds for listed hedge funds. The largest fund of hedge funds account for around 4% of industry assets. Secondary market for hedge funds is a market where investors can buy Chart 3 Concentration of hedge fund assets % share, June 7 $m-$m $m -$m $m-$m 3% Source: Eurekahedge % >$m 7% 6% % 3% $m-$m <$m Source: TheCityUK estimates % share, January 3 $m-$m $m-$m 3% 4% >$m % 6% $m-$m <$m 7% 9% $m-$m

8 HEDGE FUNDS MAY 3 into some hedge funds at a discount to the net asset value. This is an OTC market where each deal is individually priced and structured. The market allows investors to sell stakes in funds that have lockups or have limited redemptions. It also lets others into funds that aren't accepting new investors. As record investor redemptions swept over the industry in late 8 and restrictions on redemptions imposed by some hedge funds increased, many investors turned to the secondary market to try to sell their stakes. Liquidity in the market has improved since then. Hedgebay, one of the leading players in secondary market-making for hedge funds, saw its global hedge funds secondary market index fell to 8% of the average net asset value in December from over 9% at the start of the year. This was still well above levels in and. LARGEST HEDGE FUNDS The hedge funds industry has become more concentrated in recent years. In June 7, funds managing more than $m made up 7% of the industry. This grew to 4% by January 3 (Chart 3). The largest hedge funds accounted for 6% of total industry assets in. Bridgewater Associates was the largest hedge fund with $76bn under management in, followed by JP Morgan Asset Management $4bn and Man Group $37bn (Table ). The hedge fund attrition rate of around 9% in was well below the 3% high in 8 (Chart 4). PROVIDERS OF SERVICES TO HEDGE FUNDS Prime brokers offer brokerage and other professional services to hedge funds and other large institutional customers. Rather than providing particular niche services, prime brokers offer a diverse range of services including: financing, clearing and settlement of trades, custodial services, risk management and operational support facilities (Chart ). The bulk of prime brokers income comes from cash lending to support leverage and stock lending to facilitate short selling, both areas that have been affected to a large extent by the recent economic slowdown. London is Europe s leading centre for prime brokerage services and accounts for more than 9% of its activity, as the largest investment banks that provide these services are either headquartered or have a major office there. Chart 4 Hedge fund attrition rates % share Source: Hennessee Group; TheCityUK estimates Chart Services provided to hedge funds by prime brokers % share of banks surveyed providing a service Securities lending Cash lending Trade execution Clearance and settlement Fund administration Custody services Risk Management services Capital introduction Credit lines Source: Banking Supervision Comittee survey, ECB Major restructuring occurred amongst prime brokers in 8 and 9 such as the acquisition of Bear Stearns by JP Morgan, the takeover of Lehman Brothers by Barclays Capital and the acquisition of Merrill Lynch by Bank of America. This resulted in a shift in market share from some former investment banks to commercial banks. Goldman Sachs was the largest prime broker at the end of accounting for 9% of hedge funds services globally. It was followed by JP Morgan and Morgan Stanley Prime Brokerage, each with around 3% of the market (Table 3). The average margin requirement of prime brokers increased from less than % towards the end of 7 to over 4% in April 9 before gradually falling back to 34% in April (Chart 7). TheCityUK estimates that hedge fund leverage averaged 3% in, down from around % in 9 an d (Chart 8). This was also well below the average of more than 6% in the years leading up to the credit crisis. Fund administrators The extent to which hedge fund managers Table Largest hedge funds Largest hedge funds,, assets under management Bridgewater Associates JP Morgan Asset Man. Man Group Brevan Howard Asset Man. Och-Ziff Capital Man. Group BlackRock Advisors BlueCrest Capital Management Baupost Group AQR Capital Management Paulson & Co Angelo, Gordon & Co. Renaissance Technologies Corp. DE Shaw & Co. Ellion Management Corp. Source: Institutional Investor Location Westport CT, New York NY, London, UK London, UK London, UK New York NY, New York NY, London, UK Boston MA, Greenwich CT, New York NY, New York NY, East Setauket NY, New York NY, $bn

9 HEDGE FUNDS MAY 3 outsource administrative functions such as accounting, investor services or risk analysis varies widely, although stricter regulation in the wake of the financial crisis has meant that hedge funds must employ recognised thirdparty administrators in order to attract capital from investors. The largest five administrators by assets grew faster than the rest of the industry since the start of the economic downturn, and accounted for 46% of total assets under management at the end of, up from 34% five years earlier. State Street and CITCO were the largest hedge fund administrators in, each accounting for close to 3% of hedge funds assets. They were followed by SS&C GlobeOp 7.6% and HSBC 6.8% (Table 4). Managers of offshore hedge funds typically rely on offshore administrators for various types of services and operational support. In addition to helping set up the offshore fund, offshore administrators may also provide accounting and reporting services; offer advice on an ongoing basis with reference to complying with applicable laws; or offer independent pricing of a fund s portfolio of securities. Some offshore locations may subject the administrators to licensing and auditing requirements. Custody Hedge fund assets are generally held with a custodian, including cash in the fund as well as the actual securities. The flow of capital to meet margin calls may also be controlled by custodians. A trend since the start of the economic downturn has been the use of multiple custody and clearing options in order to reduce risk and further protect assets. Auditing Most hedge funds are set up in a way that does not require them to have their financial statements audited. Some hedge funds however, may undergo annual audits if this is a part of the contract between the hedge fund and its investors. This may however change if regulation of hedge funds is tightened. Some offshore locations require hedge funds to have their accounts audited. REGULATION OF HEDGE FUNDS The hedge fund industry has faced calls for stricter regulation in recent years. The Financial Stability Board, successor to the Financial Stability Forum, was established in April 9 following the G- London summit. The oversight of the new body was extended to all financial institutions important to global financial stability including for the first time large hedge funds. In the, the Dodd Frank Wall Street Reform and Consumer Protection Act was signed into law in July. Statutory changes took effect in July. The act requires advisers with private pools of capital exceeding $ million in assets to register with the SEC (Securities and Exchange Commission) as investment advisers, and become subject to all rules which apply to registered advisers. The threshold for registration of assets under management was raised from $m to $m to allow the SEC to focus on larger managers. If advisers are only working with private funds, according to the Act, they can wait to register with the SEC until they have $m assets under management, but still register with their state until then. Hedge fund managers with less than $m in assets under management are overseen by the state where the manager is domiciled and are subject to state regulation. This has significantly increased the number of hedge funds under state supervision. Chart 6 Structure of a typical hedge fund Fund Administrator Hedge Fund Manager Investors Hedge fund Dashed lines indicate optional relationships Sources: AIMA and ASSIRT Hedge Fund Booklet Chart 7 Average margin requirement % margin requirement Source: Financial Services Authority Custodian Prime broker/dealer Oct-6 Oct-7 Oct-8 Oct-9 Oct- Oct- Apr-7 Apr-8 Apr-9 Apr- Apr- Apr- Table 3 Largest hedge fund prime brokers Top prime brokers servicing hedge funds, Goldman Sachs JP Morgan Morgan Stanley Prime Brokerage Credit Suisse Prime Fund Services UBS Prime Services Deutsche Bank Global Prime Finance Citi Prime Finance Bank of America Merrill Lynch Barclays Newedge Prime Brokerage Group Top prime brokers by proportion of hedge fund launches in serviced Goldman Sachs Credit Suisse Prime Fund Services JP Morgan Morgan Stanley Prime Brokerage Deutsche Bank Global Prime Finance Source: Prequin Hedge Fund Analyst % of hedge funds serviced Switz. 9 Switz. 8 Germ France 3 Switz. Germ

10 HEDGE FUNDS MAY 3 In October, the SEC adopted rules requiring advisers to hedge funds and other private funds to report information for use in monitoring systemic financial risk. The aim is for this data to be analyzed and shared among regulators and for the SEC to report to the Congress on how the data is being used to protect both investors and market integrity. Europe In April 9, the European Commission proposed a Directive on Alternative Investment Fund Managers (AIFMs) with the objective of creating a comprehensive and effective regulatory and supervisory framework for AIFMs at the European level. The impetus for the Directive came from the G summit in London which set the path for hedge fund regulation, with G leaders agreeing that hedge fund managers should be registered by their national regulators to whom they should report systemically relevant data. The AIFMD is aimed at regulating managers of any collective undertaking which is not a UCITS. It imposes detailed regulation on non-ucits funds as well as managers, and introduces requirements relating to the safekeeping of assets, leverage, liquidity management, and valuation and pricing. The AIFMD was amended to include a European Passport scheme in October, which will enable hedge fund managers to conduct business in each member state through one registration, rather than having to register with each country individually as was originally proposed. The final agreement on the framework Directive was achieved in November and the text entered into force in July. Member States have until July 3 to transpose the Directive and its implementing measures. The AIFMD includes provision for a transitional period, allowing AIFMs up to a year in which to seek the necessary variation of permission, authorisation or registration in their home member state. UK hedge fund managers and advisors are currently required to seek authorisation from the Financial Conduct Authority (FCA). The regime for hedge fund managers in the UK is similar to that which applies to other investment managers. They are able to take advantage of the Investment Services Directive which allows them to offer their investment services to clients in other countries within the EEA. The FCA specifies restrictions on sales and marketing of hedge fund products. Hedge fund products for example, cannot be marketed to the general public but UK investors can deal directly with offshore funds. Offshore hedge funds are registered in tax neutral jurisdictions allowing investors to minimise their tax liabilities. Offshore hedge funds are usually structured as corporations although sometimes may be limited partnerships. Generally the number of investors is not restricted. Onshore hedge funds often set up a complementary offshore fund to attract additional capital without exceeding limits on the number of investors. The vast majority of offshore funds are registered in the Cayman Islands followed by the British Virgin Islands and Bermuda. Chart 8 Hedge funds use of leverage Gross market exposure as a % of assets under management, end-year 7 7 4, people employed in UK hedge fund industry Source: Financial Services Authority; TheCityUK estimates Table 4 Largest hedge fund administrators December State Street CITCO SS&C GlobeOp HSBC Citibank Others December 7 CITCO HSBC Citigroup Bank of New York State Street Others Source: Eurekahedge % share

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