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TheStreet Open House

Perceived Benefits Of Hedge Fund Regulation Deteriorates Among Investors, According To Latest Ernst & Young Global Hedge Fund Survey

NEW YORK, Nov. 5, 2012 /PRNewswire/ -- Despite increasing regulatory requirements for hedge funds, only 10% of investors feel that regulations effectively protect their interests, and 85% of investors do not believe these requirements will help prevent the next financial crisis, according to Ernst & Young's sixth annual survey of the global hedge fund market, Finding Common Ground.

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The 2012 survey, compiled by consulting firm Greenwich Associates for Ernst & Young, compares opinions from 100 hedge fund managers who manage over US$710 billion and 50 institutional investors with over US$190 billion allocated to hedge funds on current topics related to the hedge fund industry. Findings show that although the two groups agree on increasing investments in headcount, technology and risk management, stark contrasts exist on compensation structure, fees and expenses.

Ratan Engineer, global leader of Ernst & Young's Asset Management practice, says: "Our survey findings suggest that hedge fund regulations are not beneficial to investors, who overwhelmingly question their purpose and proliferation. It may still be worthwhile for hedge fund managers to constructively engage with regulators to help them stay focused on the main goal – financial stability – rather than introducing more costly or unnecessary requirements that investors feel are of little value."

Key findings from the report include:

Regulatory compliance Managers will need to commit time and resources to understanding and complying with various regulatory requirements. Managers are already seeing regulations increasing their costs in prompting upgrades of compliance functions (34%) and technology dedicated to reporting (17%). Although investors expect these additional compliance costs, they fear these expenses will be passed on to the funds.

Arthur Tully, co-leader of Ernst & Young's Global Hedge Funds practice, says: "The general increase in costs, including regulatory-related expenses, has created barriers to entry and has resulted in the consolidation of funds that do not have the capital to support the costly infrastructure required. This is a trend we will likely see continue in the near future."

Compensation Investors and hedge fund managers have made little progress since 2010 in reconciling their opinions of how compensation should align with risk and performance. In many ways, they are drifting further apart.

In 2010, 94% of managers felt risk and performance were effectively aligned with investor objectives, while 50% of investors felt the same, according to Restoring the Balance, Ernst & Young's 2010 survey of the global hedge fund market. In 2012, 87% of managers feel this is true, while only 42% of investors agree. In addition, more than two-thirds of managers say that their compensation structure has not changed in the past three years – just 14% say that less is paid in cash, and just 10% say that compensation is subject to longer deferral periods. Investors, by contrast, say less than 40% of compensation should be paid in cash; they would like to see a larger portion paid in equity and deferred cash, subject to clawbacks.

The gap between managers and investors on compensation structures is not new, but the fact that it shows no sign of narrowing may become troublesome. However, this dissonance has not caused material redemptions, nor do investors cite it as a key consideration for choosing a fund.

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