Cayman Islands: Growing Up: A New Environment For Hedge Funds

Last Updated: 28 March 2017
Article by Rupesh Daya

Rupesh Daya explains how the results of a recent survey demonstrate how the hedge funds climate is evolving.

The hedge fund industry continues to face pressures to transform. Managers are forced to become more focused on evolving regulations, operational effectiveness, alignment of interests and delivering value to their investors. New strategies, new investors and demands for more customised products and services are changing the market dynamics.

The changes are impacting almost every facet of hedge fund management. In recent years we have seen changes in fee structures, product mixes, target markets and investor types. KPMG, the Alternative Investment Management Association and the Managed Funds Association partnered to undertake a survey that looks at the impact of these changes. The survey, titled Growing up: A new environment for hedge funds, included over 100 hedge fund managers that together represent approximately US$440 billion in assets under management. The respondents included managers located in North America, the United Kingdom, other areas of Europe and the Asia-Pacific region. Managers expect the industry AUM to continue to grow, on average, at 10% per year. Institutional investors are expected to continue to be the industry's primary source of investment, further eclipsing high net worth individuals. Traditional fee arrangements are being cast aside in favour of more customised models. New markets are expected to emerge for both capital and investment destinations. Some managers are customising their products to broaden their appeal, and many are adopting liquid alternative products in response to investor demands. The impact of new regulation remains a concern and is creating barriers to growth in most markets.

The key survey findings include:

  • The majority of managers believe that pension funds will be their primary source of capital by 2020, with public pension funds and sovereign wealth funds together accounting for at least a quarter of capital inflows by then.
  • Two thirds of managers think their client demographics will be less concentrated in the next five years, and only one in five say they will be the same. Product diversification such as liquid alternatives and customised fees are anticipated to attract additional investors.
  • 46% of respondents expect to either alter their fund strategy or launch new products to attract institutional investors in the next five years, while more than two-thirds say they expect to offer specialised fee structures.
  • 43% of respondents said they expect to change the markets in which they invest their capital, and 21% said they would invest more into developed markets, while 30% pointed to the emerging markets and 7% to frontier markets.
  • Managers are moving towards customised product offerings with almost half of all fund managers reporting they already offer a fund of one or managed account solution and 21% saying they plan to offer these solutions within the next five years.
  • 38% of respondents said they either had, or were developing, a UCITS fund, with 27% saying the same about 40-Act funds.
  • Three quarters of respondents said they expect the number of hedge fund managers to either decrease or stay the same over the next five years.
  • More than three-quarters cited increased regulation as the biggest threat to the industry overall, with 84% saying their operating costs had increased as a result of compliance obligations.

The global trend of ageing populations has implications for the needs of investors, and particularly institutional investors who are becoming increasingly attracted to low volatility returns over extended periods of time. Hedge funds are likely to receive increased allocations as investors look to optimise risk adjusted returns in a low bond yield environment. The needs of the investors are forcing managers to adapt in order to retain and attract capital. One manager noted, "Investors – particularly institutional investors – are demanding more detailed reports from their fund managers, arguing that they should have the same level of granular data that regulators enjoy". Managers are evolving from providers of products to providers of customised solutions.

Managers expect the level of competition to level out, with the cost and complexity of regulation being a key challenge to the industry. The increased complexity has forced many managers to have costly dedicated regulatory and compliance functions, while others are looking for more assistance from service providers. One large manager commented that institutional investors will continue to invest with small fund managers where there is a commitment to following best practices and a strong track record. With evolving regulations, Cayman Islands service providers have been swift to adapt systems and offerings to support their clients' regulatory compliance and reporting needs. Common Reporting Standard (CRS) deadlines are approaching and after successful implementation of US and UK FATCA services lines, service providers are well equipped to offer a full suite of compliance services and expertise. The Cayman Islands have been at the forefront of global CRS implementation and are part of a group of 50 jurisdictions that committed to early adopting the standard, demonstrating the Cayman Islands' commitment to adopting the highest standards in tax transparency.

When asked about where they would domicile new funds setup in the next five years, managers said that they would most likely domicile their master funds offshore, with 64% identifying the Cayman Islands as their jurisdiction of choice. The enactment of the Limited Liability Companies Law, 2016 further strengthens the Cayman Islands position by providing a new flexible structure that is very familiar to US based managers.

As regulations mount, capital markets morph and investor needs change, managers are forced to do more than ever before to retain and attract capital. The Cayman Islands' legislation also continues to evolve to ensure that Cayman continues to be the hedge fund jurisdiction of choice. Service providers have expanded their service lines and developed their expertise in order to provide timely and efficient solutions to clients. It is clear that while the industry is facing tremendous pressure to transform, the Cayman Islands will continue to play a significant role in its future.

About the Author

Rupesh is a Director with KPMG's Alternative Investments practice in the Cayman Islands. With over 10 years of experience in the financial services industry, Rupesh's portfolio includes a wide range of hedge funds, mutual funds, private equity funds and investment management entities.

Rupesh is a member of the South African Institute of Chartered Accountants and the Cayman Islands Institute of Professional Accountants with a Bachelor of Accountancy degree from the University of the Witwatersrand, South Africa.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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