Hedge Fund Demand and Capacity, 2005 - 2015 Is Worldwide Hedge Fund Demand Outstripping Capacity?
Among its findings, the white paper (available at www.vanhedge.com) concludes that hedge fund assets, now at $1 trillion, will at least double by 2009, quadruple to $4 trillion by 2013 and sextuple to $6 trillion by 2015.
Comparison With Past Mutual Fund Growth
"We believe that these projections are conservative," stated George Van, Chairman. "Demand for hedge funds is at unprecedented levels and the worldwide capacity for hedge funds is growing. It took the mutual fund industry 66 years to attain $1 trillion in assets. It has taken hedge funds ten years less to reach the same level." Van added, "Mutual funds grew more than fourfold in the seven years between 1990 and 1997, after they had reached $1 trillion in assets. Hedge funds are in the same growth mode. While they currently are private investments, hedge funds will become public securities in various forms. This will accelerate their growth." He then described the widespread skepticism that greeted VAN's hedge fund growth forecast in the 1990's: that the hedge fund industry would reach $1 trillion in assets by 2005.
Reason For Current And Future Hedge Fund Industry Growth
Van explained that hedge fund industry growth is driven by a fundamental fact: hedge funds produce better risk-adjusted returns than traditional, long-only investments. He said, "Ask the long-time sophisticated hedge fund investors such as Harvard, Yale, the University of Virginia, large family offices and Swiss banks whether they agree that hedge funds produce better performance. Ask also the many institutions that are now investors in hedge funds because their long-only investments plummeted up to 40% in the recent bear markets while hedge fund investments preserved capital. The hedge fund industry has grown steadily for 17 years. While it will take at least another year for it to fully digest recent massive capital inflows, growth will then again accelerate."
Demand And Capacity Will Grow Together
VAN's study states that demand will accelerate both because of the better performance of hedge funds and also because hedge funds have reached their "tipping point".
Capacity is expanding to meet demand. Hedge funds are implementing new strategies and entering new markets.
New, expanding sectors include energy, private equity, real estate, middle-market lending and asset-backed financing. Capacity growth also has been facilitated by the increasing use of exchange-traded funds (ETFs) and credit derivatives.
New markets for hedge funds include both developed and developing economies. Developed economies beginning to embrace hedge funds include Canada, some European countries and Japan. Developing economies beginning to adopt hedge funds include Brazil and South Africa and, in Asia, Hong Kong, Singapore, Taiwan, and Korea. In a few years, China and India will add enormous capacity.
Some Perceived Obstacles To Growth Not Problematical
The study states that certain characteristics of many hedge funds will not noticeably impede growth. These characteristics include high fees, low liquidity, low transparency, and leverage. Similarly, new and anticipated regulation will have only an imperceptible impact on both U.S. and non-U.S. industry growth.
Leverage Lower Than Generally Believed
The VAN study found that, as of year-end 2004, 20% of hedge funds used no leverage whatsoever while another 50% used leverage of less than one time their equity, including short positions. These statistics belie the widely-held belief that most hedge funds use large amounts of leverage.
New Registration Regulations Will Not Affect Growth
Many hedge fund managers, worldwide, are understandably concerned about new SEC registration regulations. These regulations require that U.S. and offshore hedge fund managers register with the SEC by February 2006, if they have a specified number of U.S. investors and certain other characteristics. VAN believes that, while unregistered U.S. hedge fund managers are reluctant to register with the SEC, most will have to do so.
The costs of SEC compliance are not insignificant in absolute dollars. However, the rewards of managing even a moderately successful hedge fund are so great that new compliance costs will have a de minimus impact. The study states that new registration regulation will not affect growth of the hedge fund industry, either within or outside the U.S.
Unprecedented Demand Stresses Some Traditional Strategies
At one end of the spectrum, highly specialized traditional strategies, that access narrow slices of the markets, have been stressed by the heavy capital inflows of 2003, 2004 and 2005 to date. These specialized strategies include Statistical and Convertible Arbitrage. The latter appears to be recovering well. However, investors should be aware that the same capital inflows that recently swamped convertible arbitrage funds could well flood in again when that strategy returns to solid profitability.
At the other end of the spectrum, hedge fund strategies that have access to broad and deep markets have remained virtually unaffected. These include Futures and Macro strategies.
Between the two extremes described above, other traditional strategies have been impacted but most will recover, especially with their ability to expand into non-traditional markets such as developed and developing countries that are just beginning to use them.
Total Impact of Funds of Funds Unrecognized
The assets of funds of funds ("FOFs") are growing dramatically. From a few dollars in 2000, their investments in individual hedge funds now approximate $400 billion, or about 40% of industry assets.
It seems likely that the growth of FOFs will continue at a faster pace than that of individual hedge funds.
The Majority Of Hedge Fund Products Will Become Public Vehicles
We already are seeing early signs that this will occur in the not-too-distant future. For instance, the registration of U.S. hedge fund products is growing. There were no such registrations in early 2000. Today, approximately 60 brokerage firms have registered FOFs with the SEC. As one of a number of parallel developments, Charles Schwab Corp. and some competitors are attempting to replicate hedge fund advantages with mutual funds that do some shorting. In Europe, institutions have been registering hedge fund products for years and the volume sold to retail investors is growing rapidly.
The increasing proliferation of hedge funds and their growing use by smaller investors will force the inevitable: in coming years, the majority of hedge fund products will be public vehicles.
Strong Growth Ahead
Van concluded, "Hedge funds are emerging from a difficult period that has been caused by positive reasons: their outperformance and the resulting high demand. For the most part, existing hedge fund strategies are adjusting to unprecedented demand. New strategies are meeting with success, both in traditional markets and elsewhere. Industry assets will increase dramatically in coming years."