A recent Preqin report stated that 61% of hedge fund assets now come from the institutional sector – a 36% rise from 2008 – and that 84% of hedge funds expect this trend to continue in the next year. These figures illustrate the widely shared admission in our industry that institutional and pension monies are increasing their investments into hedge funds.

Hedge funds remain attractive to institutional investors for their ability to use derivatives which provide leverage, hedging capabilities and exposure to underlying global assets. However, the use of derivatives does not come without inherent risk and institutional investors have a penchant to minimize risk whenever possible. According to the Prequin report, risk management is the fourth most important factor for investors when selecting a fund, behind strategy, track record and performance.

Increase in due diligence
Since the credit crunch of 2008, both investors and regulatory bodies have been pressing fund managers to increase the institutional quality and capabilities of their overall information systems. Some regulations seek to control risk and asset exposure (UCITS IV) while qualified investors are thought to be protected by enhanced reporting requirements as seen in Form PF (Dodd-Frank legislation), or new requirements for European funds (AIFMD). Added to this are more rigorous due diligence interviews being conducted by investors before making their asset allocations.

Investors are now demanding increased transparency and granularity around many areas of the investment process. One area of focus is to investigate source of returns and ascertain how some asset classes are monitored and controlled. Detailed questions around resource risk, auditability, pricing policy, robustness of controls and platform infrastructure are all being asked. Investors also check how quickly a manager can respond to external ad hoc reporting requests, particularly in light of recent counterparty failings. Before investing in a fund, investors want to ensure fund managers are able to respond quickly on where cross-asset exposure lies with respect to any attribute, be it counterparty, issuer, currency, country, sector or industry. Managers running their investment processes on offline spreadsheets or multiple systems will struggle with these demands, and yet they are only becoming more onerous – some fund managers go through over 60 due diligence meetings a year.