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The former reality of frequent hedge fund launches is no more, with tighter fee margins and higher costs weighing down the industry. While, according to a recent article by the Economist, billion dollar hedge fund launches typically were viewed as commonplace in the past, current new offerings are generally much smaller and less frequent, causing serious implications for the industry and those seeking hedge fund jobs.

Smaller funds also tend suffer from reduced economies of scale. The article suggest that at a two percent fee rate, a $100 million hedge fund can expect to earn $2 million in a year, leaving little remaining after paying required salaries and bonuses. Larger funds can benefit from economies of scale as many compliance, accounting and legal costs tend to be fixed, rather than variable in comparison to assets under management.

Increased Compliance Costs Continue to Weigh on Hedge Funds

These increased compliance costs are a major factor weighing on the industry. The Economist article blames the Madoff scandal for the increased regulatory burden, but in fact, the reality goes much deeper. The overall financial industry is facing increasing compliance and regulatory costs as a result of public concerns over accountability following the financial crisis. Unfortunately for hedge funds, as some of the smallest players within the industry, the burden falls more harshly on organizations without considerable scale.

Fewer Financial Professionals are Leaving Big Institutions

In the wake of the financial crisis, restrictions on banks trading their own accounts increased. This resulted in many star traders being forced out of their positions at large institutions, with many deciding to start up new funds. This flow of financial professionals has slowed considerably now that the industry has largely completed that shakedown, which may contribute to the reduction in the number of new hedge fund ventures. A long track record of trading success is required in order to stake it out by oneself in the financial industry, and simply put, these individuals either have remained retained by their big firms or have already started their own hedge funds or wealth management practices.

What are the Implications for Hedge Fund Job Seekers?

The news of declining hedge fund launches on the surface seems like a negative trend for those seeking opportunities within the industry. With fewer players, it seems as though fewer opportunities would exist. In some cases, this may be true, but it doesn’t paint the entire picture. While there may be fewer players, the overall assets under management in the industry have largely remained intact, meaning many of the jobs that would have been required to manage funds in new firms are simply managing the funds in larger firms. The relationship may not be one to one due to those economies of scale, but the situation is certainly not as bleak as it may appear at first glance. Larger firms may also offer opportunities to lesser experienced individuals, whereas small shops require all team members to have a great depth and breadth of knowledge and experience.

Further, those increasing compliance costs generally reflect the salaries of skilled financial professionals hired into compliance-oriented roles, which represents a fast growing source of opportunities throughout the financial world. While on the surface the news of declining hedge fund launches may not seem positive, there are numerous opportunities if job seekers look beyond new start-ups.

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Though much of the financial industry has accepted and instituted stronger compliance and oversight measures following the financial crisis, a recent report from Risk.Net leaves many wondering if the hedge fund industry is on the same page. According to a Corgentum Consulting survey of Operational Due Diligence (ODD) analysts, a large majority of risk professionals indicate that compliance and regulatory issues are the leading risks facing hedge funds today. This was followed by accounting and financial statement reviews, legal issues and business continuity risks.

Changes in financial regulation in the United States and around the world have brought increasing regulatory pressure and oversight to an industry that largely operated under the radar in the past. As a result, many firms have little experience in dealing with the complex rules and requirements of the new oversight practices. And the pressure keeps growing. Approximately 1,500 hedge fund managers were forced to register with the Securities and Exchange Commission in 2012 due to provisions under the Dodd-Frank Act, and along with this registration came increased regulatory burdens. These burdens are also not static and therefore require ongoing monitoring and analysis to ensure that firms stay up-to-date with the compliance practices necessary to avoid significant regulatory penalties.

Adding to the complexity, regulation is not uniform worldwide. In fact, the landscape is dramatically shifting in nearly every geographic environment. This creates a very dynamic environment in which hedge funds must constantly evaluate practices to ensure full compliance with complex and changing rules. The implementation of the European Union’s alternative investment fund managers (AIFM) directive is one such change that will bring significant risk to hedge funds operating in the region. Along with these changes, similar regulatory developments are occurring in some Asian markets. This requirement for cross-jurisdictional compliance in such a dynamic environment adds a significant challenge for traditionally small hedge fund management teams.

Most Hedge Funds Poorly Positioned Today to Deal with Regulatory and Compliance Risks

Due to the organizational realities of most hedge funds, regulatory and compliance management are generally not seen as strengths for most organizations. The small team nature of most firms has generally meant in the past that accountability for compliance has been spread out through the organization, with most individuals responsible for ensuring their segments complied with relevant rules and regulations. In the modern compliance environment, however, this is simply insufficient. Investors are pressuring funds to adopt comprehensive compliance management frameworks, with firms reluctant to change being left behind by proactive managers.

Increased Compliance Represents Opportunity for Job Seekers in the Hedge Fund Industry

As late adopters of integrated compliance frameworks, hedge funds will be actively seeking compliance and risk management professionals in order to get their firms  up-to-speed. This issue is of extreme importance, with investors anxious that funds in non-compliance could put themselves in regulatory danger. As a result, financial professionals with experience in compliance and regulatory matters will find themselves in demand over the coming years as hedge funds begin to shift in line with the broader financial industry.

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The Value of Hedge Fund Regulations Questioned

November 19, 2012

After the 2008 stock market collapse, hedge funds faced increased oversight and regulation by financial authorities around the world. This not unexpected, as hedge funds can be amongst the riskiest investment classes in the market, though this is certainly not always true. Nonetheless, the industry as a whole was painted by the same brush, causing […]

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