The hedge fund industry is experiencing a transformation. The old distinctions that underpinned hedge fund portfolio construction are rapidly evolving. Typically, investors pointed to hedge funds’ unconstrained approach to investing to achieve outperformance while relying on traditional active and passive fund managers to help them earn the market return (beta).
The alpha-beta returns dichotomy of yesteryear’s industry model is being replaced by a new range of solutions, tailored to the needs of an increasingly diverse investor universe.
Collectively these constitute a paradigm shift in the hedge fund landscape. Central to this shift are the arrival of smart beta and alternative beta investment solutions, which are fast becoming mainstream. These solutions have emerged from years of financial innovation, primarily by early hedge fund pioneers, and are now being provided by banks, hedge funds and other alternative asset managers. By investing in these products, investors can have access to traditional hedge fund exposures at a much lower price than was previously the case.
This disaggregation has led to a better understanding of the drivers of hedge fund exposures. Subsequently, investors are being compensated for a range of risks, including market beta, smart beta, alternative beta and risk premia.
The commoditisation of these strategies has allowed large institutions to invest at scale and, in the face of more challenging performance in recent years, they have been snapped up by many investors.
The increasing influence of cutting-edge statistical and computational tools, including advanced quantitative techniques and some early forms of artificial intelligence, is driving hedge funds to a new way of operating and investing.
Over the next decade, the advent of big data, artificial intelligence and immense computational power will enable a completely new set of hedge fund strategies. The hedge fund industry has always been at the forefront of rigorous data-driven investing, and the new technology available to hedge fund firms will allow them to make use of the greater volumes of data becoming available every day.
The hedge fund firm of the future will comprise more mathematicians and computer scientists instead of traditional business school graduates. This is pushing hedge fund firms into direct competition with the technology industry to attract and retain the brightest talent.
The industry has attracted and retained notable names from Silicon Valley and other recognised technology hubs in recent years. Central to this fourth revolution is hedge funds being forced to focus more on their business and distribution models as competition for capital investment intensifies. Ultimately, hedge fund managers desire to seek talent with technology and data analytics skills is driven by investors’ appetite to do things quicker, faster and at the best price available for them.
Amidst all these changes, hedge funds will continue to offer alpha. They will need to compete harder and evaluate ways of using different investment time frames. Given the rarity of the skill needed to deliver alpha, investors will continue to pay a premium to those who can deliver it consistently.
Tom Kehoe is global head of research and communications at the Alternative Investment Management Association
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