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The hedge fund industry as well as traditional asset management is beginning to implement lower cost structures as economic uncertainty and increasing pressure from clients over fees weighs on their business. Unfortunately for hedge funds, the reality of continuing under the 2 percent plus 20 percent of returns fee structure is quickly coming to an end, as investors demand reduced rates, especially the large institutional investors that fundraisers covet.

Ongoing weak economic conditions have created years of low returns, which in turn cause investors to look for additional ways to keep their portfolios intact. One such area for risk free gains is clearly the reduction of fees. As institutional investors struggle to make minimum return hurdles for their long term obligations, portfolio managers are demanding lower fees, or they are simply moving their money elsewhere. Increased competition within the industry certainly favors the institutional investor over the hedge fund manager.

Hedge Funds Remain a Viable Alternative to Fixed Income

While the battle on fees continues, hedge funds are uniquely positioned to offer a product that is attractive to many portfolio managers. In light of historically low fixed income yields, managers are looking for alternative investments that offer low correlation to equity returns, but still provide more return than the two or three percent achievable with a low risk bond portfolio. The competitiveness, including fees, of hedge funds versus a low cost bond index portfolio remains the question at hand. Funds that can outperform fixed income benchmarks including fees may be in a stronger position to negotiate higher fees than those funds that aren’t earning returns that justify the higher management cost.

Regulatory Changes are Driving Higher Costs

While investors are demanding decreased fees, hedge funds are facing the increased cost of complying with ever more complex regulation. In the United States as well as in the European union, dramatic changes to securities regulation has increased legal and compliance costs associated with managing a fund. Unable to pass these costs on to fee-sensitive investors, funds are looking to cut elsewhere in order to maintain acceptable margins. Unfortunately, most often the cuts target fund employees.

What does this mean for those seeking Hedge Fund Industry Jobs?

While the news of cost cutting in the hedge fund industry certainly does not bode well for job seekers when taken in isolation, there are some positive signs within the industry for those looking for work. The alternative investment class in general is set to experience growth due to its unique position to offer higher returns than fixed income while maintaining low correlation to equity indexes. This should attract additional client funds.

In the short term, regulatory uncertainties and squabbles over fees may cause some firms to hold off on hiring or make slight cuts, but hedge funds are in far better condition than other segments of the financial industry, such as investment banking, for example, where hundreds of thousands of jobs are being shed. For talented and experienced individuals, opportunities will continue to present themselves among successful hedge funds, namely those that can successfully justify their fees to their client investors.

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Hedge funds across the world are cutting trading desk resources as pressures on the financial industry continue. In a recent Greenwich Associates survey reported by Bloomberg, 44 percent of hedge funds indicated that they will reduce their spending on trading activities this year in comparison to 2011. This is largely the result of increasing pressure on funds to reduce costs as they struggle to justify their management fees in the light of rising equity markets.

Hedge Fund Performance Weak so far in 2012

So far in 2012, hedge funds have largely trailed comparable equity indices, with Reuters reporting that equity focused hedge funds had gained only 5.8 percent in the nine months ended September 30, 2012, while the S&P 500 index gained 16.4 percent. While certain funds have seen success in 2012, such as Daniel Loeb’s Third Point Offshore Fund with a 10.9 percent gain and the Tiger Global fund posting a 22.4 percent gain, the majority of equity focused funds have struggled. This has made it difficult for fund managers to justify their management fees, which are usually considerably higher than fees charged by equity index funds, to investors. In order to reduce costs, such funds are slashing their trading budgets.

This underperformance is clearly reflected in the Greenwich report. While 44 percent of hedge funds are expected to reduce staffing levels, only 20 percent of a broader basket of financial companies are expected to cut trading expenses, and 30 percent actually expect to expand their desks. Investor money generally follows returns and this is no more evident than in the hiring intentions of money managers across various investment classes.

Return to the Roots of Hedge Funds May Create Limited Opportunities

While certain investors certainly will struggle with the current performance of hedge funds in comparison to potential investments in equity indices, they don’t have to look far in the past to find times when hedge funds were the star performers. The reality is that hedge funds are designed to offer consistent returns through time and not necessarily track or outperform an equity index during every single time period. Current uncertainties in the markets are forcing portfolio managers to look for alternative asset classes that offer returns that are not linked to equity indexes, but that are higher than current historically low fixed income yields. This offers some promise to hedge funds that have produced consistent results over long periods of time.

Even the Greenwich report suggests some upside for those looking for trading opportunities in the hedge fund sector. While it’s true that the majority of hedge funds were reducing trading staff or holding steady at current levels, 17 percent of funds planned an increase in resources for the year. This is likely focused on high performing funds that are constantly attracting more capital, or hedge funds focused on consistent returns that are drawing investor money as an alternative to low fixed income yields.

Job Seekers see a Mixed Outlook

Overall, the outlook remains mixed, with more downside than upside, for those looking for trading work in the hedge fund sector. While select high performing funds are growing their trading operations, the majority are holding steady or cutting staff. This means that competition will be fierce for the limited opportunities that are available. Those looking for work in this sector should be prepared with advanced education in finance and several years of experience with strong results in order to be a star candidate for an available position.

Over time, if fixed income yields remain low, a greater shift may occur towards the hedge fund industry in terms of investor capital. This could generate further employment opportunities down the line, but this could be years off, or in the case of a rebound in bond yields, it could never happen at all. It remains advisable to be opportunistic in this industry, seizing upon any available opening when possible.

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