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Foundation & Endowment
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A PUBLICATION OF INSTITUTIONAL
INVESTOR, INC.
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AUGUST 1999 GOING THE WAY OF THE MUTUAL FUND Lucrative. Fragmented. Individualized. All describe the mutual fund industry in its infancy circa 1980 and, many would agree, the hedge fund industry today. In a recent discussion on the evolution of the hedge fund industry, Rama Rao, CEO of RR Capital Management, outlined his case that the hedge fund industry is heading on the same track as mutual funds-an institutionalized, global industry that, like mutual funds two decades ago, stands poised to explode. Rao spoke last month at the Managed Funds Association's "Forum99: The Forum for Managed Futures & Hedge Funds," in New York (see related story, page 4). In a study released earlier this year, Rao and Jerry Syilagyi, director of financial services at KPMG Consulting, estimate hedge fund assets will grow from about $200 billion to at least $1.7 trillion over the next decade. They estimate that foundations and endowments, which make up only a small percentage of total hedge fund assets, will allocate an estimated $16 billion to hedge funds by 2009, up from an estimated $3.2 billion in 1997.
Investors will demand more transparency and performance attribution. Eventually, as was the case with the mutual fund industry, consolidation and increased competition for assets will drive fees down. "As the hedge fund industry becomes more institutionalized, the pressure will be on managers to offer the most competitive fees," he said. Looking at the mutual fund industry, which has some $6 trillion in assets, a majority of the assets-80%-are controlled by families of mutual funds. "In 1980, the percentage of assets controlled by mutual fund families was only 20%," he said. Rao is quick to point out that funds-of-funds differ from a family of funds in that with the former, the fund manager picks the funds; a family of funds is driven by the investor and thus families are set up off a centralized platform to offer a full palate of styles and strategies. "There is no Fidelity of the hedge fund world right now," Rao asserted. "The closest thing is Paloma Partners, Soros, these have multiple funds, but these fund managers dictate the styles, which are similar. There is no family of hedge funds incorporating a full array of strategies." Just as a mutual funds' success rises and falls with the Morningstar rating attached to it, Rao sees an emergence of rating systems from hedge fund performance data providers such as TASS, Managed Account Reports, HFR and Barron. Recently, Tremont Advisers, which owns TASS, joined forces with Credit Suisse First Boston to create a hedge fund index. As Rao's session was coming to a close, an audience member, Joe Pescatore, who heads up the absolute return strategies group at State Street Global Advisors, took issue with the thrust of the hypothesis. Pescatore argued that the barriers for entry were low enough and
Plus, he said, it's going to be difficult to institutionalize
the entrepreneurial hedge fund culture. If big money managers, banks
and insurance companies start making inroads, it's liable to cause
the top talent to walk: "What's left will be the second stringers
and investors will always want the A-team." Rao countered that
a proliferation of information and increased comfort levels led
to the takeoff of the mutual fund industry, and the same will hold
true for hedge funds. "The number of potential investors in
hedge funds is smaller than with mutual funds, but the assets this
group controls are much higher." |
"The hypergrowth rate in mutual fund assets lasted more than
20 years," Rao said, adding that the upward inflection of growth
for hedge fund assets is only entering its 10th year. The study
pegs total hedge fund assets at $1.7 trillion a decade from now,
with $200 billion in new hedge fund assets coming from institutions,
mostly pension funds, because those assets comprise the largest
piece of the overall institutional pie. "Extrapolations take
into consideration a 10% growth rate in institutional assets and
the assumption of only a negligible increase in allocation,"
Rao said afterwards. "But all indications are that foundations
and endowments will increase their allocation percentages because
they don't have any ERISA restrictions. Pension fund and insurance
allocations will remain lower because of restrictions."
distribution
was on a wide enough scale that when the mutual fund industry hit
its point of inflection, that is when the growth curve began its
upward slope, the industry took off and never looked back.rrao@ramarao.com