Rising Number of Hedge Funds Shift to Family Offices

The hedge fund population is getting thinner as more and more firms convert to family offices, according to news site and peer group network COOConnect. “Hedge funds are increasingly contemplating launching family office structures and we have seen north of 100 different funds converting to family offices,” said hedge fund sales director Keith Gertsen.

“The primary reason for this is the cost of regulation and maintaining operational overheads. Total spend by hedge funds on operational and back office functionalities is very high, and consumes a significant chunk of Assets under Management (AuM),” he added.

Considered as further catalysts for the institutionalization of the hedge fund sector, are the constantly demanding regulatory changes that cause higher operational costs and management fees. “The Citi Hedge Fund Expenses Benchmark Survey published in early 2014 found the average manager required at least $310 million for their two per-cent management fee to pay for their regulatory and operational expenditures,” COOConnect added.

The impact of these overwhelming fees to the hedge fund industry came like a nuclear bomb last yearas the number of new hedge fund manager start-ups fell by 40 per cent compared to 2013 – the lowest record since 2003.

Some of the regulations that increase barriers to entry, due to the financial demand that they impose,include Alternative Investment Fund Managers Directive (AIFMD), the Foreign Account Tax Compliance Act (FATCA), the Dodd-Frank Act in the US and the European Market Infrastructure Regulation (EMIR).

Of these regulations, KPMG’s case study “The Cost of Compliance” shows that AIFMD has the highest cost of compliance (with about 46 per cent of all respondents voting for it), followed by SEC registration and reporting and FATCA.

Results of the study further imply that the hedge fund industry is allocating at least USD3 billion on regulatory compliance alone, including technology, headcount and third-party vendors.

Explaining the negative impact of these rising costs to new players, a fund manager from Asia shared that, “The entire nature of the alternative investment industry – particularly the hedge fund industry – is one of innovation and finding new ways to achieve alpha. There’s no doubt that regulation is constricting this and making it harder for new players to enter the market.”

Meanwhile, hedge fund managers that have made it to the game but struggling to survive find salvation in shifting to family offices. Aside from lower operating costs, Hannah Shaw Grove, a family office expert and board member of the Hedge Fund Association., shared that one of the main reasons why even successful hedge funds switch to that industry is because family offices are not as constrained by investment objectives as a pure-play asset manager.

“Other family priorities such as tax efficiency, philanthropy and asset protection can be considered and more fully accommodated in the investment process than they might be otherwise,” she added.