Credit Suisse 2010 Global Manager Survey

Liquidity and due diligence terms evolving

Originally published in the May 2010 issue

To misquote Mark Twain – there are lies, damn lies, and surveys carried out by banks who are trying to push a particular perspective. And we admit that we do have an ulterior motive in this survey, as we do in our forthcoming corresponding survey of hedge fund investors’ appetite – to help managers and investors to understand each others’ perspectives and plans as much as possible, with the ultimate goal of facilitating the greatest possible sustainable flow of capital from investors into the alternative investment management industry.

Our detailed survey of investors in 2009 showed that investors were becoming more activist regarding many issues that they perceived to have arisen from years of mismatched supply/demand dynamics. One year later, as the industry appears to be recovering its health along many dimensions, this survey revisits the discussion of how managers and investors are interacting with each other, and provides:

1. A different perspective to the discussion on the future shape of the industry, because it comes from the supply side, which is much less frequently surveyed than the investor community.

2. An update at a pivotal time in the industry’s evolution, because it is only now starting to become clear whether the recent rebound in both performance and inflows will re-set the supply/demand imbalance.

While there are a number of useful surveys of the investor community regularly prepared there are very few representative surveys of the supply side of the industry – what are managers thinking? What are they planning to do in response to investor activism? It is not surprising to see investors asking for transparency, liquidity and lower fees – but how are the managers reacting to this? It is to answer these questions that we asked hundreds of our Prime Services clients, in all regions, across all strategies, and of all sizes, to help us to gauge managers’ views on a number of the topics that are highest on investors’ agendas right now:

Liquidity terms – Are investors really getting the higher liquidity they have been asking for? The result: yes, occasionally – over 40% of managers have enhanced liquidity, although in a number of different ways.

Economics – On what aspects of fees are managers likely to negotiate, and in return for what? The result: under 10% of respondents expect lower fees in general, but over 50% will negotiate for specific goals.

Due diligence – Are managers really experiencing this getting longer and deeper? The result: yes, this survey shows that average duration has increased 30%, with sub-3 month due diligence by fund of funds dropping by 75%.

Transparency – How many investors have actively sought greater transparency, and in what forms? The result: 96% of managers have seen greater demand for transparency – but are responding in different ways.

UCITS – How many managers are looking seriously, and what are the motivations? The result: while only 9% of all managers globally have a UCITS fund, over 70% of European managers either manage or are considering launching one. We uncover that their primary goal is to source institutional capital.

Managed accounts – Was this a temporary surge in demand, and if not, will supply match demand? The result: only 17% of managers witnessed a temporary surge, with 69% still seeing increased demand, and an impressive 86% either offering or considering offering managed accounts.

Investor-manager interaction
What follows is a look into these questions in more detail which presents a rare view of the supply side of the industry as it stands today, at a pivotal moment in the evolution of the industry. Why is today pivotal? Because many commentators think that the interaction between investors and managers in 2010 may dictate whether the industry will fall into one of these two extreme hypotheses:

The “Managers’ Paradise” i.e. now that inflows appear to be recovering, and demand for alpha is soon set to exceed its supply again, almost all of these compromises will soon be refused by managers, who will take advantage of their superior bargaining power to revert to theindustry’s original structure – untransparent, non-negotiable fees, limited flexibility in vehicles, take-it-or-leave-it bargaining.

The “Investors’ Paradise” i.e. the combination of poor performance in 2008, plus the even greater failures in terms of frauds, unmonitored counterparty losses and excessive asset/liability mismatches, has galvanised investors and embarrassed managers such that from now on investors will be able to determine all of the parameters they care about – maximum transparency, maximum liquidity, and flexibility of investment vehicle.

A sustainable model
We don’t think that either of these is realistic, or sustainable, and the results of our two current surveys, plus many hundreds of anecdotal observations and conversations, lead us to a conclusion that differs markedly from each of these extreme views – a conclusion that may perhaps be best called the “Sustainable Model”. Under this model, it is not a question of who has the stronger bargaining position, as both managers and investors are increasingly coming to realise that they need to view each other as long-term partners, and that all of the terms and other aspects to each investment need to be agreed with that in mind – sustainable profitability for all. That is what the responses to each of the questions above indicates – that supply and demand are moving closer together than they have ever been, in an appropriate and sustainable manner.

If we can summarise this Sustainable Model in one word, it is that all terms should be “appropriate”. Our view is that liquidity terms, transparency, fees, and willingness to accommodate alternative investment vehicles will be neither the “too little” that some investors believe has existed in the past, nor the “too much” that some managers believe is being asked of them now – but rather will come down to what is “appropriate” in each case, taking all circumstances into account. Thus, we see liquidity terms increasingly being discussed in terms of what will permit the manager to pursue their strategy in an optimal manner, yet without requiring investors to forego flexibility unnecessarily. Similarly, we see transparency being structured in such a way that investors get a superior understanding of return drivers and risk exposures, yet the investment strategy is not put at risk by excessive disclosure. This has been our advice to managers launching new funds for quite some time now – treat your investors as your long-term partners, and propose terms and structures that are appropriate for both sides of the industry. Not only will you raise more money, but you may keep it a lot longer.


Industry outlook
Before addressing managers’ sources of capital, we wanted to assess broadly how managers felt about 2009 and how they feel about capital raising opportunities in 2010. There are some quite different views on the health of the industry in 2010, with at least 3 quite divergent reports having come out both on the lingering impact of high watermark issues across the industry and the resultant financial viability of a large proportion of hedge fund managers, so we started by asking managers whether they had grown during 2009, taking both performance and flows into account.


Remembering that the industry as a whole returned between 15-20% depending on which data provider you ask, and that generally the industry returned to positive inflows from approximately July or August 2009, it might be somewhat surprising to see that over one third of respondents actually suffered a net decline over the period. There are many factors at play here, but some of the key ones included:

– There was an unusually high amount of performance dispersion within each strategy over 2009, particularly because many managers had explicitly decided to be either “short-term opportunistic” (and thus took on a degree of market exposure) or “medium-term cautious” (who let their concerns over fundamentals steer them into flat books).

In most strategies therefore – including macro, long-short equity and long-short credit – we saw as many managers within 5% of flat as we saw within 5% of +25%.

– This phenomenon of differentiated risk appetite had a second consequence – those managers who had had a “moderate” 2008 (e.g. a loss of 5-10%) may have retained considerable investor capital coming into 2009, but if they then failed to get sufficient risk back on the table to capture some of the 2009 upswing, investors may have started to lose patience, leading to delayed redemptions.

– Related to this, there was significant recycling of capital within the industry, from those managers and those funds who were perceived to have got it wrong too many times, into those perceived to have had a “good crisis”, and who had responded not just in terms of performance but also in terms of increased investor friendliness and “corporate governance”. The rest of this survey touches on many of the things that this latter group did well.

– Additionally, those managers who lost most assets in 2008, and who still had residual high watermark issues throughout 2009, had to take distinct steps to convince investors not just of their longer-term viability, but also of their short-term focus on performance. Without convincing action, such funds risked falling into a redemption spiral.

Due diligence
The number of extremely well known failures of due diligence over the last two years – for reasons that span style drift, unmanaged counterparty exposure, excessive asset/liability mismatches, aggressive valuations and outright fraud – has clearly put a lot of pressure on all investors, both intermediaries and end-investors, to significantly tighten their due diligence procedures in order to minimise such risks in future. With this background, it is not surprising that managers reported to us that an overwhelming 87% of investors have been taking either “Significantly Longer” or “Somewhat Longer” to complete their due diligence than pre-crisis.


One of the most frequently used words in the context of hedge fund investing since the events of late 2008 is “transparency”, usually preceded by the word “more”. But what exactly is being demanded? And what is really being offered? We asked managers a number of questions intended to estimate both demand and supply of transparency, but we also sought to get into more detail on precisely what is meant by transparency. We see a movement already underway towards “appropriate” transparency instead of simply “more at all costs”, and managers are increasingly trying to understand what is behind investors’ requests for transparency – in many cases, they don’t actually want daily runs of all positions, but rather want to be able to understand their key return drivers and primary risk exposures better, which can often be achieved in a way that does not impact the manager’s ability to perform. Starting with gross demand, Fig.3 reveals that an overwhelming 96% of managers experienced investors asking for either “significantly more” or “slightly more” transparency, so the extent of the demand is clearcut. What is more interesting is that 51% of managers already offer greater transparency (see Fig.4), so there is clearly already a significant move towards giving investors what they want. (As an aside, it is difficult to reconcile Fig.3 with the fact that 45% of managers state they have “always been as transparent as investors request”, unless you add the addendum “and really need”.)


We also probed into the primary motivations for any reluctance or inability to provide more disclosure. We suggested 4 different issues that managers have raised with us, and were pleasedto see that “Operationally too cumbersome” was the least important of the hurdles. The number one most commonly cited reason for limiting transparency was the fear that, where even a part of a portfolio may involve price sensitive assets, that excessive disclosure could have a direct impact on performance. The fear of reverse engineering of strategies was of lower importance, although was higher as a percentage of quantitative strategies.


With the economics of the hedge fund industry continuing to be much debated, we asked managers their views on situations in which market standard fees are likely to change. Only a small minority of 12% of bullish respondents generally expect no decrease across the industry, although a roughly equal minority of 9% of pessimistic respondents expect fees to generally decrease across the industry. We think that neither extreme view is likely to be correct in the medium-term future.However, one of the clearest indicators of the trend towards compromise across the industry is that almost two-thirds of respondents believe that fee reductions will be offered to investors in exchange for commitment of capital for longer periods. Essentially, managers are saying “I will give you something that you value in exchange for you giving me something that I value”. This also meshes with well publicised statements of several large institutional investors who said that liquidity terms would have to match portfolio liquidity – but that if managers wished to receive longer commitments of capital, they would consider doing so, usually in return for a reduced management fee, and often also a restructuring of the performance fee observation period.

In another sign of the concept of “appropriateness” becoming the litmus test for fee levels and fee structures, over a third of respondents also believe that hedge funds fees should be linked to the amount of “beta” that is inherent in a particular fund; as certain investors have put it to us, “I am not paying performance fees for beta”, and some have gone so far as to say that certain strategies, or certain approaches within strategies, are “just not 2+20 strategies”, with a hurdle rate for the performance fee being one of the most common stipulations. Similarly, almost one third of respondents also believed that those managers with less experience would likely have to start to offer more fee reductions. We next turned to specifics on which aspects of fees were typically being negotiated, and in what circumstances.

In line with respondents’ views on the widespread reduction of hedge fund fees for investors who agree to lock up their capital for longer, over half of managers have already reduced their management fees in return for longer lock-ups or are considering doing so. Similarly, approximately half of respondents have reduced their management fees in return for early capital in a new fund and a roughly equal number have reduced their management fees in exchange for “sizeable tickets”.

There was materially less support for a different approach to revising management fees – to tie fee level to the overall fund size. Many investors are concerned about managers becoming “asset gatherers”, which is usually defined as a business model that is more focused on income from management fees on a large asset base, rather than income from high performance fees due to strong returns on a more controlled asset base. Those investors comment that the fixed costs of doing business are not scalable as asset size grows, and therefore that management fees should not be strictly proportional to asset size either – they should step down as AUM hits certain pre-agreed levels.

As can be seen in Fig.6, only 2% of respondents have already done anything similar, but we are aware of a number of recent launches who have added quite innovative elements into their fee structures, with a few including some genre of asset-linkage. Investors have welcomed this broadly, although in a few cases, the proposed fee structure was so complicated that investors had difficulty understanding the precise mechanics.


We were unsurprised by the finding in Fig.6 that managers have been distinctly less willing to negotiate on their performance fees than they were on their management fees. This tallies with a study that we recently did to compare the terms of new launches in the first half of 2009 versus new launches in the first half of 2008; we found that over 80% of funds maintained a “full” 20% performance fees, whereas just under 50% of funds had maintained the “full” 2% management fee.

What are the conclusions for investors? In short, that being able to negotiate on fees is not a foregone conclusion today, but that investors will greatly improve their chances of doing so successfully if they offer managers something tangible in return, such as a longer commitment.