Hedge-fund assets seen hitting low of $1 trillion - Madoff Fraud

Hedge-fund assets seen hitting low of $1 trillion
Study finds assets could rebound to $2.6 trillion by 2013

By Simon Kennedy, MarketWatch
Last update: 10:50 a.m. EDT April 20, 2009Comments: 2
LONDON (MarketWatch) -- Global hedge-fund assets will drop to around $1 trillion in mid-2009, driven by hefty withdrawals by European high-net-worth clients, before rebounding over the next several years, according to a study by Bank of New York Mellon and management consultant group Casey Quirk.
The projected nadir for the industry represents a decline of nearly 50% from a peak in assets of around $1.9 trillion in 2007, according to the study, which surveyed 158 institutional investors, consultants and hedge funds.
Bank of New York Mellon and Casey Quirk are predicting that total assets could rebound to $2.6 trillion in 2013 as North American pension plans become an increasing important source of new funds for the industry. But they added that the study found "key shortcomings" over transparency and fees need to be addressed.
Hedge funds have traditionally relied on the prime brokerage divisions of major investment banks to provide custody services for their investments as well as other accounting and administration services.
But following the collapse of Lehman Brothers and the Bernie Madoff fraud scandal, investors are demanding tighter controls and greater transparency.
One example is increased demand for independent custodians, with Bank of New York Mellon looking at ways to embed its custodial services within prime brokers, according to David Aldrich, business manager of Bank of New York Mellon's hedge fund and broker/dealer businesses in Europe.
"So if we had a repeat of Lehman Brothers, the administrator would easily see who the assets belong to," he said.
Investors are also likely to balk at the some of the hefty management charges and the additional performance fees hedge funds charge -- in some cases 20% or more of the gains above a certain level.
One option is for performance fees to be charged on a rolling basis, which would smooth out the big peaks in fees in the strongest periods and allow funds to "keep the lights on" during period of weak returns when they would otherwise not receive any performance fee.
"Enduring hedge-fund management firms will more closely align their business models with investor needs for transparency and liquidity. This means new fee models and longer-term incentive structures," said Kevin Quirk, a partner with Casey Quirk.
The study also predicted that funds of hedge funds will solidify their role as the main source of new money for hedge funds through 2013.
Some of these funds, which invest their clients' cash in a pool of different hedge funds, have been criticized for investing money with Madoff. But the study said that for most investors, funds of hedge funds still represent the only viable way to access hedge-fund strategies because their portfolios aren't large enough to invest directly in lots of different hedge funds.
Simon Kennedy is the City correspondent for MarketWatch in London.