Hedge Funds See Increasing Costs for Good Performance

May 10, 2006 (PLANSPONSOR.com) - While seeking new sources of capital, dealing with increased regulation and expanding into new markets, hedge funds are finding that their search for alpha is now more costly, according to TABB Group's second annual study on hedge funds.

According to “Hedge Funds 2006: The Quest for Alpha in a Competitive World,” spending on prime brokerage has risen to $10 billion, while investments in market data and technology exceed $1 billion, TABB Group said in a news release. In addition, to register with the Securities and Exchange Commission (SEC) and meet new regulatory requirements, funds have spent more than $500 million over the past five years, far exceeding the $113 million the SEC estimated it would cost the industry.

The search for alpha drives funds’ increased expenditures on highly specialized forms of data, independent research and access to company management and expert networks, explains Adam Sussman, senior consultant at TABB Group and co-author of the report, the release said. Writes Sussman, “The manager who can cut through language and cultural barriers, local regulations and disparate accounting conventions will be able to locate good ideas on a global basis.”

Research analyst and report co-author Matt Simon notes that two-thirds of the funds are planning to expand into other areas over the next two years, up from 41% that broadened their exposure over the last two years. “The perception is that the US markets are overcrowded, with too much cash and not enough opportunities,” he said.

The expansion increases reliance on prime brokers for instruments such as margin, securities lending and OTC derivatives, technology – trading platforms, reporting packages and basic risk management software – and back office-related services, including custody, clearing and settlement, according to the report. As a result, the average US hedge fund, including offshore clones, will spend $4 million in 2006 ($10 billion industry-wide), with a huge portion of spending coming from funds with over $1 billion in assets under management.

Additional findings in the report include: 

  • TABB Group estimates total spending in the US by hedge funds on data at an average of $432,000 per annum per fund, allocating as well significant amounts to market data terminals, historical databases, low-latency, real-time data feeds and national and industry publication subscriptions.
  • Nearly 30% of funds are planning improvements in front-office technology by 2007.
  • Hedge funds with six or more relationships are consolidating most of their business with fewer prime brokers, while nearly half are considering adding or switching to a new broker.
  • While nearly 50% were not concerned with SEC registration, those that spent between $64,000 and $374,000 on the registration process, largely dependent on the size of the fund, were well above the SEC estimate of $45,000.
  • Hedge funds expect overall assets from pension plans to climb from 15% in 2006 to 19% in 2008.
  • TABB Group also expects advanced electronic trading to pick up in other liquid issues, such as exchange-traded equity derivatives, US Treasuries, certain corporate bonds and major foreign exchange pairs.

The report is available now for purchase at www.tabbgroup.com/research .