In the recent survey, only 13% of institutional investors said they plan to increase their allocation to traditional hedge funds in the next three years. The figure was down from 17% of participants who eyed an increase in capital in traditional funds in 2013, and lower from 2012 when there were 20% of respondents who said to invest in the same.

 

In the latest survey, about 13% plan to decrease their allocation to traditional funds, and 74% expects to keep investment at current levels.

 

In North America and Europe, investors reducing their allocations outweighed those increasing by approximately 25%, says the report. Among those investors that would like to increase or maintain allocations, 40% say they face obstacles such as allocating too much to a single asset class.

 

Michael Serota, co-Leader, global hedge fund Services at EY, says: “Given this backdrop, managers are trying to offer investors more flexibility on fees and tailored offerings via separately managed accounts and long-only funds.”

 

“They are hoping to attract a new class of investor – private wealth platforms – as well as developing registered liquid alternatives products to try to attract new investors. The largest managers are even developing sub-advisory capabilities and insurance-related products,” says Michael.

 

 

Nearly one in four managers that launched a product in the last three years say new products have had a negative impact on margins. This is particularly true of those that offered sub-advisory arrangements, with 43% saying it had a negative impact, against 21% that recorded positive impact on margins.

 

Registered products and separately managed accounts clearly create risk for margins as well. The report says 30% of hedge funds say launching registered products has hurt their margins -- 45% of those who offer UCITs say margins have been negatively impacted, while 24% say separately managed accounts have done so.

  

“The impact on margins for these new products is logical. Separately managed accounts often come with fee concessions that impact margins and add complexity to reporting; sub-advisory relationships can carry unique reporting requirements and service provider demands; and registered liquid alternatives are lower fee products that require significant investment to set up,” says Brian Thung, Wealth and Asset Management (WAM) Asean Leader at EY.

 

“In fact, the negative impact on margins is most acute in Europe and among larger managers. Having said that, our survey shows only 11% of Asia-Pacific managers have indicated this negatively affected their margin,” says Thung.

 

Regulatory reporting expenses can translate into an added drag on margins, reaching 6% on average, assuming a historical margin of 30%, says the report.

 

 “Regulatory reporting expenses, which were negligible even a couple of years ago, have grown significantly and are now impeding managers’ bottom line, Thung adds.

 

In addition, cloud computing and cybersecurity have become major concerns across the hedge fund industry for regulators as well as investors, says the report.

 

Of managers surveyed, 85% say that security concerns are the main impediment in using the cloud, and although 80% of managers expect to increase their spending on cybersecurity, few have made investments thus far.

 

Fewer than one in three investors are confident in their managers’ cybersecurity policies. Given that cybersecurity is a significant risk, managers need to prioritize their investment strategy in this area, EY says.

 

 

 

The report also says 46% of the largest managers surveyed, with more than US$10 billion under management, offer or plan to launch more registered funds, including UCITS. About 32% are focusing on separately managed accounts; 14% offer or plan to launch sub-advisory capabilities; and 11% plan to launch insurance-related products.

 

Similarly, the top priorities for mid-size managers, with US$2 billion to $10 billion under management, are separately managed accounts, 28%; and registered funds, 31%; whereas smaller funds, with less than $2 billion, are most focused on developing their long-only offering, 35%.

 

“Our survey shows that managers who have not yet launched new products often underestimate the investment required to successfully bring a product to market and do not perform sufficient planning – this is particularly true for registered funds due to the increased operational complexity in reporting and compliance functions,” says Serota.

 

Managers think that registered liquid alternative products require the most investment to set up, with 29% of respondents expecting to have to make a very significant investment.

 

More than half of managers say they are making the most significant investment in new technology to support their new products. Thirty percent of managers launching separately managed accounts are making the biggest investment in the front office, compared to 15% of those launching registered products. But 12% of those launching registered products are also making significant investment in the back office.

 

Larger managers cite challenges in developing infrastructure and hiring key personnel. But when it comes to capital raising, just 8% of larger managers said this was a challenge compared to 33% of mid-sized managers, and 47% of smaller managers. In addition, the smallest managers also struggle with distribution channels, with a third naming this as the biggest challenge in adding new products or offerings. 

 

“Investors consistently report that, when selecting a manager, they are most interested in the clarity of the investment philosophy and developing confidence in the management team. But there seems to be a mismatch between this and what managers think the decision is being based on, which is long-term and short-term investment performance. Given the increase in new products, it is more critical than ever that managers give investors confidence in their ability to generate future returns at appropriate risk levels rather than peddling past performance,” says Thung.