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One of the next growth opportunities for the hedge fund industry may be the retail market, as investors increasingly seek out alternative asset classes. With analysts predicting that retail assets for the industry will climb to $940 billion over the next four years, from only $305 billion at the beginning of 2013, this represents a major opportunity for hedge funds, if they met these lofty expectations.

The Financial Times argues the trend is a convergence of traditional asset managers seeking out products with higher returns and hedge funds looking for additional capital. The demand from asset managers is a result of the struggle to offer alternative products to compete with low fee exchange traded funds (ETFs). While hedge funds certainly don’t offer lower fees than ETFs, they do offer strategies that can be marketed as unique and advantageous for investors. This is especially true in comparison to active equity or bond funds that as a whole haven’t been able to justify their fees in comparison to their ETF peers.

Mutual Fund Firms Snap Up Hedge Fund Managers while Retail Funds Launched

The mutual fund industry has been quick to move into the hedge fund space in order to establish a presence. Franklin Templeton was one mutual fund giant that was active in the hedge fund space, acquiring a majority position in K2. Legg Mason also was involved, adding Fauchier Partners to its group.

While these managers have been busy making acquisitions, hedge fund managers have been launching retail-oriented funds on a more frequent basis. Highbridge and AQR have recently released their own retail funds, while KKR has launched a fund to be distributed to retail clients by Charles Schwab. All of this stacks up to increasing pressure on the traditional mutual fund industry.

Shift in Fee Model May be Behind the Movement

One of the leading factors in the increased interest in retail hedge funds may come from how asset managers are compensated by their clients. Sandy Kaul, head of business advisory services for Citi Prime Finance, told the Financial Times, “In the US wealth adviser market there has been a shift in the pay structure, away from fee-based commissions over the past 10 years, and an increase in fees on assets under management.” As a result, wealth managers are looking to hedge funds to preserve asset value, and therefore, their fee revenue.

What are the Implications for Hedge Fund Job Seekers?

The potential for large scale retail acceptance of hedge funds is an important development for those currently in the industry or potentially seeking future opportunities. Many analysts have wondered where exactly future growth for the industry would come from, and in the past, retail investors would have seemed like a long shot. But recent regulatory changes and growing enthusiasm from money managers seems to be changing that belief. Retail hedge funds are increasingly viewed as a core component of future wealth management offerings. As a result, the increased growth potential of the industry should come as welcome news for those in the industry or considering a future in hedge funds.

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It is no secret on Wall Street that hedge fund returns haven’t been a source of excitement this year. In fact, hedge funds have struggled to post gains of only 4.6 percent to date, despite the S&P 500’s meteoric climb past 15 percent in the same span of time. While many would expect hedge fund managers to be concerned about their performance, Kevin Roose of New York Magazine reported that the atmosphere at the fifth annual SALT hedge fund conference remains upbeat. That’s because, even with the considerable under-performance to date and over the past few years, the hedge fund industry continues to earn high fees as well as attract large sums of new investment capital. Why is this?

It comes down to institutional investors, particularly pension funds, that aim for regular, consistent absolute returns every year, something equities cannot provide alone due to market volatility. In the past, these investors could diversify their portfolio using bonds, but the current interest rate environment isn’t providing sufficient levels of returns in order for the funds to meet their hurdle rates. So pension fund managers are looking for alternative asset classes that have characteristics similar to bonds, but offer higher returns. Some private equity strategies offer these types of returns, but more commonly, hedge funds are viewed as the answer. Hedge funds that employ market neutral strategies in particular that offer consistent, albeit lower, returns over time have seen a lot of attention from struggling pension portfolio managers.

In exchange for offering more management intensive strategies, hedge funds generally charge fees substantially higher than what one would see in an actively managed equity fund. Typically, this is done as a 2 percent fee upfront for assets under management and 20 percent cut of any profits the fund earns. While some would anticipate fees would come under pressure due to the low levels of returns, the industry isn’t really seeing any decline in their revenues.

“I keep waiting for fees to go down, but they’re only going up,” Jan Buchan, a hedge fund industry veteran, told Roose at the conference.

This view is consistent with the results observed amongst leading funds. For example, John Paulson, who has lost $9.4 billion over the past two years for his clients, is still charging his regular fees. In fact, he’s still attracting investors. As an overall industry, hedge funds took in $817 million in new investor capital in April 2013 alone. There certainly isn’t a great deal of pressure on this group of fund managers, despite less than stellar returns.

What are the Implications for Hedge Fund Job Seekers?

As a result of stable fees, hedge funds have been able to offer more stable opportunities than their financial industry peers in investment banking or asset management. While there has been some pressure on the regulatory front that has increased expenses, along with jurisdictional questions for some funds, hedge fund employees have largely been able to rely on their employment more than their peers. This should continue into the foreseeable future, as long as interest rates remain low and hedge funds are positioned as one of the most attractive alternatives to the fixed income asset class.

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Hedge Funds Look to Japan for Opportunity

May 6, 2013

After decades of lackluster and even declining performance, Japanese equities are seeing renewed interest from hedge funds across the world. As the Bank of Japan enters a new era of loose money policy, mostly implemented through quantitative easing similar to that being undertaken in the US, a declining Yen has the largely export-focused Japanese economy […]

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Hedge Funds Lured by Unconventional Locales

April 29, 2013

Hedge fund managers might want to begin to learn some Czech as the Eastern European nation becomes one of the latest countries attempting to kickstart a domestic financial industry. The opportunity to establish Prague as a financial center comes as a change in European Union regulation, coming into effect in July, gives preferential treatment to […]

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New Hedge Fund Launches Decline

April 22, 2013

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 […]

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Hedge Funds Face Growing Concerns over Perceived Corruption

April 15, 2013

Following the financial crisis, the general public has become increasingly skeptical of the financial industry, questioning whether many firms, including hedge funds, are acting ethically. According to an article from Forbes, there may be merit behind that skepticism. Referring to a report published by New York law firm Labaton Sucharow, which specializes in class-action securities […]

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Hedge Funds Face Compensation Overhaul

April 8, 2013

Over the past several years, since the height of the financial crisis, the financial industry faced increasing criticism regarding executive compensation. Around the world, taxpayers saw financial institutions being bailed out with public money, while bankers in general were forced to sacrifice very little. While there were some short term reductions in bonuses and incentives […]

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