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Where Do We Stand Now?
As we hypothesized in the forth quarter of 2008, we have seen the large investment banks loose their mystique, boutique investment banks gain top talent and alternative investment vehicles having their choice of top talent. Although hiring has stayed slow due to the overall market conditions and the inability for many funds to obtain leverage and financing, those Private Equity and Hedge Fund firms with additional capital on hand in many cases have used this capital to hire top talent.
This talent has either brought with them very strong rolodexes or the specific strategy knowledge that these funds needed in order start a new strategy or build out a new clientele. We have seen these funds expand their businesses to not only include investment management but market making and investment banking. These firms have maintained or built out their infrastructure so that they are ready for the asset growth they expect and desire.
What will Happen to Hedge Fund and Private Equity Firms?
But the question remains: What will happen with Hedge Fund and Private Equity vehicles? I believe these investment firms will survive and strengthen over time, if for no other reason then their numbers have dropped and many bad funds have been cleaned out of the system. Due to the money which sits on the sidelines, I believe many of the stronger funds will see significant growth in the next few years and as we have discussed before these large funds will be complemented by the creation of small specialized funds which will create tremendous alpha for investors willing to accept a little more volatility.
These specialized funds will need to hire the best investment talent within their strategies. In order to retain talent, funds may start offering a percentage of the firm’s “carry” or actually equity ownership in the fund. We saw this theory of smaller alpha producing funds taking a more significant role in the space with an allocation just last week by a west coast investor of $300 million to an emerging manager hedge fund program.
Era of Regulations
There is no question that regulations will be placed upon the alternative investment universe which will raise the cost of running a Private Equity or Hedge Fund firm. These regulations will most likely involve many areas of the business but most surely better transparency will be a large part of the regulations. This transparency will be required for not only the fund’s investment holdings but for the firm’s entire operating procedures.
Out Come of Regulations
These regulations will offer an opportunity for professionals to find new employers and to create value for their employer on day one. Obviously these regulations will require for many firms additional hiring in infrastructure related roles but I would argue these regulations will also require additional hiring in investment related roles since now strategies will have to be run even more efficiently and effectively. This demand for experienced individuals especially those in infrastructure related roles will cause the compensation for these individuals most likely to increase in the next few years and cause the balance of performance fees to be spread out further within the organization.
We are specifically seeing this in the Private Equity space where those funds that share a percentage of the firm’s carry with the majority of their employees are having an easier time raising assets during this very difficult fund raising time. Investors want everyone’s interest to be aligned!
Just as the cost of Sarbanes Oxley has negatively affected many smaller public companies and those private companies looking to go public, the cost of these new regulations will affect many start-up and smaller hedge funds. These new costs will most likely raise the barrier of entry into the Private Equity and Hedge Fund industries. In my opinion, this would be a good thing for everyone involved in the space.
With a higher barrier of entry more unqualified or mediocre start-ups will either not be started or will have to close their doors within a year, keeping the space less crowded and hopefully improving the overall performance of the space. These new barriers will strengthen the industry’s reputation and make the alternative investment space an important part of any asset allocation model. Although I do believe and hear that fees are presently being pressured this barrier could allow firms to stabilize their fee structure and perhaps raise fees in the coming years.
Changes are occurring in the space but I believe these changes could be good for all involved:
1. These changes will increase hiring needs within the space
2. Increase compensation in the space, more performance related
3. Stabilize and perhaps even increase fees structures in the near future
Although the alternative investment space is presently experiencing a tough time, I believe in the near future the coming changes will be beneficial to our industry. Hedge Funds and Private Equity firms are still very strong alpha producers especially compared to many of their benchmarks.
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