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Hedge Fund Assets to Double to $5.8 Trillion by 2018, Driven by Diversity and Focus of Offerings: Citi Investor Services Survey

5th Annual Hedge Fund Survey Examines Industry in Optimization Phase as Investors, Managers Engage in Symbiotic Relationships, Expand into Capital Market Functions Beyond Asset Management 

The hedge fund industry has survived the global financial crisis, diversified its offerings beyond its traditional investor bases, and is currently in a phase of optimizing its business operations and offerings, according to Citi Investor Services’ 5th Annual Industry Evolution survey.

By all metrics, the industry is thriving, with assets continuing to grow to new record highs. Citi sees the total pool of capital being advised by hedge fund managers doubling from $2.9 trillion in 2013 to $5.8 trillion in 2018.

In addition to offering more access to retail investors and creating customized solutions for institutional investors, hedge fund firms are increasingly engaging investors in an advisory capacity to support their clients’ overall portfolio, and expanding into functions beyond their traditional role as just asset managers.

“The hedge fund industry is entering its next evolutionary phase – one of optimization – a term we use to describe how firms are expanding, customizing and focusing their overall businesses,” said Sandy Kaul, U.S. Head of Business Advisory Services at Citi. “Investors are increasingly looking at hedge fund firms more as consultative partners to construct customized portfolios and capture new avenues of uncorrelated returns. In addition, the industry as a whole is beginning to fulfill some of the roles that banks used to traditionally own.”

Isolating Risks, Playing the Role of Banks

Another theme of optimization drawn from the survey is that the industry’s largest allocators are blurring the lines between investors and hedge funds. Many of the leading institutions that invest in hedge funds have built out their own asset management organizations to complement their specific exposures from hedge funds. These investors have also built sophisticated risk and portfolio management platforms, which allow them to run analyses on position level information being fed to them by their underlying hedge fund managers.

This is allowing some investors to co-invest into securities and to directly invest into markets alongside their hedge fund counterparts. These participants are also helping to fill a market-making and lending gap that has emerged from sell-side banks that are pulling back, and increased sensitivity to balance sheet impacts from the traditional dealer community. Underlying hedge funds themselves are also filling this bank-like role and diversifying their offerings.

Those investors that are too small to trade alongside their hedge fund counterparts are showing other signs of optimizing their approach to portfolio construction. Several survey respondents discussed their move to create opportunistic allocations that they saw existing outside their core hedge fund holdings. In most instances, these investors were looking to take advantage of idiosyncratic niche or “exotic” alpha opportunities over a specified lifecycle.

More than Just “Alpha”

Once known for seeking “alpha” or excess return beyond a benchmark, hedge fund managers are leveraging the broad investor community’s increased focus on categorizing the types of “beta” risk in a portfolio and how to improve upon those return streams. This is an extension of a trend of institutional investors having moved from singular “hedge fund” exposures to a more nuanced approach, where different investment strategies fall into categories based on risk profile, transparency, liquidity and directionality.

In some instances, this led to more hedge fund managers being given allocations to run long only funds as assets under management in this category rose to a new record of $183 billion in 2013. In other instances, the drive to identify diversifying or alternative beta streams allowed for the successful launch of niche, specialist strategies that invest in assets that provide revenue streams un-correlated to the securities markets such as airline leases and other real asset based strategies.

The Citi Investor Services Annual Hedge Fund Survey May 2014 full report can be viewed online.

Citi, the leading global bank, has approximately 200 million customer accounts and does business in more than 160 countries and jurisdictions. Citi provides consumers, corporations, governments and institutions with a broad range of financial products and services, including consumer banking and credit, corporate and investment banking, securities brokerage, transaction services, and wealth management.