Hedge funds could make inroads into market-making and asset
servicing in a bid to counter competition and fill gaps left by
banks and broker-dealers.
Traditional lines distinguishing hedge funds from their
clients and competitors are "increasingly blurred", experts at
Boston Consulting Group (BCG) argue.
As a result, services routinely provided by sell-side firms,
including liquidity provision and custody, may start to appeal
more to alternative managers.
"Banks and broker-dealers are responding to burdensome new
regulations and reduced returns by contracting their capital
market offering," writes Brent Beardsley, a New York-based
senior partner at BGC.
"This gives hedge funds the opportunity to enter new lines
of business, such as lending, market-making and asset
servicing," he adds in a new report, entitled 'Hedge Funds
– Down But Not Out’.
Large banks operating as custodians, such as BNY Mellon and
JP Morgan, have doubled down on their asset servicing
commitments in recent years – boosting their
technology spend and enhancing client service.
However, regulations have added complexity to the business
along with considerable margin pressure. New technologies,
notably blockchain, are also forcing incumbents to revisit
their operating models.
Aside from asset servicing, certain hedge funds have already
begun to provide more liquidity in foreign-exchange markets as
traditional dealer banks step back due to stricter
Direct lending is another area of opportunity for
alternative managers amid still tight lending from traditional
Hedge fund struggles
Average hedge fund gains totalled 7.4% in 2016 according to
data from Preqin - the best showing in three years.
However, experts at the firm said managers will be
aware that in recent years returns have "still fallen short of
other alternative asset classes and public market indices".
This is especially pertinent in the wake of some
high-profile investors eliminating or reducing hedge fund
investments from their portfolio, such as giant state pension
plans in New Jersey and Rhode Island.
Meanwhile some largest hedge fund clients, including
sovereign wealth funds, are becoming more sophisticated and
often now use the same tools and technologies to execute their
own investment strategies.
Asset managers are also encroaching on hedge
funds’ territory by investing in liquid
alternatives or by acquiring or partnering with hedge
In a worst case scenario, BCG’s report predicts
industry-wide hedge fund assets could shrink by as much as 30%
by 2020 and margins could fall by 20% as a result of fee
reductions and increased capital expenditure.
Even in a more favorable so-called "momentum scenario",
hedge funds will have to retool and reorganise, according to