Once a cure for insomnia, hedge fund operations now keeping everyone awake at night

Hedge fund operations have been thrust onto the front pages over the past 6 months as a result of some high profile cases of fraud, proposed new regulations and redemption gates. So we’ve come to Grand Cayman this week to find out how the hedge fund community is responding to these pressures. Much of this year’s “GAIM Ops” program focuses on due diligence, liquidity, third party administration and compliance - all of which have suddenly become key sources of competitive advantage in the post-Madoff world.

We’ll try to live-blog part of this one for you (as we did for Battle of the Quants in NY in February) so stay tuned. In the meantime, here is a round-up of stories that have caught our eye recently…

Power to the Hedge Funds! Long demonized, they may be the model firms of the future (Newsweek): It has become very rare for a mainstream media outlet to endorse the hedge fund industry. Is Newsweek’s piece last week a sign that mainstream anti-hedge fund rhetoric is waning? You be the judge.

“The industry’s total capital plunged by $600 billion to $1.33 trillion as of the end of the first quarter of 2009, during which investors yanked another $104 billion out of them, according to data released Tuesday.

“But here’s the key point: the fallout happened very quietly-with no systemic risk discernible. Compared to the overlong horror movie we’ve been watching-Night of the Living Dead Banks-what happened in the hedge-fund world sounds almost healthy and clean. After all, that’s the way capitalism is supposed to work: incompetents go out of business, smart guys clean up. And overall, the hedge-fund industry has shown remarkable resiliency in the face of the catastrophe, turning in a gain of 0.53 percent in the first quarter.”

Demand for Hedge Fund Separate Accounts ‘a Knee-Jerk Reaction’ (Bloomberg): A couple of weeks ago we wondered if the sudden popularity of managed accounts might actually have a negative effect on many investors. Now some experts are questioning the very basis for the trend.

“Hedge fund investors’ growing demands for separate accounts may be an overreaction to increasing redemptions and fraud, participants said at an industry conference in Hong Kong this week.

“‘I think the demand for managed accounts is to some extent a knee-jerk reaction to the liquidity mismatch that the industry has had,’ said Au King-lun, chief executive officer of the Hong Kong office of Financial Risk Management, a London-based fund of funds manager overseeing $10 billion.”

According to a forecast from Casey Quirk and Bank of New York Mellon last week, funds of funds will soon represent only 43% of HF assets. This, after making up nearly half in 2007 (see chart below from report).

This may have been a pretty good call. Data released by HFR last week shows that 85% of redemptions in Q1, 2009 were from funds of funds. That means that the funds of funds seem to have been sitting on idle cash waiting for redemption day - essentially creating a buffer between the single managers and the redeeming investors. Critics will wryly suggest that funds of funds do have some redeeming qualities after all (at least, last month).

Bank cutbacks aid hedge funds (Financial Times): Not only are banks providing hedge funds with less competition for talent (see, for example, “Star commodities traders ditch banks for hedge funds“), not now they’re leaving the best trades for them too.

European pension funds increase weightings in non-traditional asset classes (Mercer): More evidence that alternative investments aren’t going away any time soon…

“Following last year’s unprecedented market conditions, European pension schemes are increasing their allocation to non-traditional asset classes to manage their risks more effectively, according to Mercer’s annual European Asset Allocation Survey. The survey of over 1,000 European pension funds with assets of €400 billion found that 35 percent of UK schemes and 60 percent of European schemes (excluding the UK) expect to introduce new investment opportunities into their portfolio to help manage future investment risk.

“Tom Geraghty, European head of Mercer’s investment consulting business commented: ‘Despite being innately diverse in history, culture and regulatory requirements, European pension funds have all felt the effect of the last year’s market turmoil. The banking crisis and collapse of Lehman Brothers highlighted the operational risks associated with the investment of institutional assets and brought counterparty credit risks more into focus. Funds are now looking at ways to manage the risk inherent in their schemes, mainly through further diversification of their assets.’”