Perspectives on the Hedge Fund Industry ByMr Ng Nam Sin, Executive Director,Financial Centre Development, Monetary Authority of Singapore
BNP HF Symposium: The Future of the Hedge Fund Industry
1 A very good afternoon to all. It is my pleasure indeed to join all of you here today. Before I begin, I would like to thank Patrick Fauchier and BNP Hedge Fund Centre for organizing this symposium.
Impact of the Crisis on the Global Hedge Fund Industry
2 The hedge fund industry as a whole ended 2008 with the worst performance ever, with the Eurekahedge Hedge Fund Index registering negative 12.5%. The significant losses led to massive redemptions resulting in a severe decline of 35% in global AUM from the peak in mid-2008 at almost US$2 trillion to US$1.3 trillion in Apr 2009. The hedge fund industry in Asia, which is much smaller and younger than in the US and Europe, saw its AUM falling by about 40% from its peak. In Singapore, the AUM saw a decline of 22% to S$61 billion as of end Dec 2008.
3 Given this, some observers saw this as a sign of the demise of the hedge fund industry. However, signs and developments suggest otherwise. I say so for a few reasons.
4 Firstly, hedge funds have held up reasonably well during the crisis. While hedge funds collectively ended last year in negative territory, their losses were on average far less severe than the markets. Hedge funds outperformed broader market indices such as the MSCI World Index and S&P 500 by 23% and 19% respectively in 2008.
5 Secondly, hedge funds will continue to have an important role to play, not just as providers of absolute returns in economic environments where traditional investing may face constraints, but also as providers of risk/return opportunities. With the current low yield environment, hedge funds provide avenues for higher yielding returns.
6 Thirdly, with the capacity to adopt a wide range of strategies, hedge funds are also better positioned to generate returns that are less correlated to the general markets. Given this, investors are increasingly recognizing hedge funds as a source of diversification.
7 More recently, investor sentiment on hedge funds is also picking up with net inflows since May, performance back in positive territory and more talent coming out to set up their own hedge funds. All these point to the recovery of the industry.
8 However, the landscape on which hedge fund operates will be quite a different one from the past. We say so for a few reasons;
Risk Management and Transparency
9 Firstly, recent events have made investors more demanding in terms of their expectations for proper risk management and greater transparency. According to a Deutsche Bank Alternative Investment Survey published in March 2009, risk management and transparency have moved up in importance to become the second and fourth most important characteristics that investors look at when selecting hedge funds.
10 Indeed, the challenging market conditions have sparked a renewed focus on risk management. As seen in the recent crisis, taking excessive risk without putting in place necessary risk controls is a recipe for failure. The crisis also brought to light the need to focus on liquidity and counterparty risks, apart from market and operations risk management. As investors become more discerning, putting in place proper risk controls will no longer be an option, but rather, a critical requisite for hedge funds to institute.
11 The crisis has also highlighted the importance of transparency with respect to the operation of hedge funds, including their investment strategies and processes. Investors have learnt the hard way that they can no longer live by faith in the “black boxes” of hedge funds alone even if the past track records had been excellent. Investors need to know if the hedge funds are indeed performing according to what they have claimed in their prospectuses.
12 Going forward, it is clear that greater transparency and proper risk controls will have to go alongside investment performance and it is critical that hedge funds have such infrastructure in place. Post-crisis, it will be hedge funds with more robust risk management frameworks and proper infrastructure that will be well-positioned to regain the trust of investors and to meet the new challenges ahead.
13 Secondly, in light of the above changes, there have been renewed calls for more regulation for the hedge fund industry.
14 While hedge funds were clearly not the cause of the crisis, the crisis has most certainly brought to the fore the significance of hedge fund activities in the markets, and the associated risks.
15 Internationally, there have been numerous calls by key organizations such as G20 and IOSCO for greater regulation of the industry. For example, IOSCO, in its six high level principles on the regulation, has recommended that hedge funds should be subject to mandatory registration. In June this year, the Obama Administration also released a draft white paper proposing that advisers to large hedge funds should register with the SEC, among other things.
16 On this front, MAS is monitoring market developments and global initiatives, and will fine-tune our regulatory approach as appropriate. As we align ourselves with international standards, we will also be mindful of maintaining a balanced approach and not to ‘over-swing’ the regulatory pendulum.
17 Thirdly, the need to build competency. Hedge funds is a talent-driven industry. A big part of building a successful hedge fund hinges on finding the right talent and building the right competencies.. Here I would like to share with you what Singapore has done to build competencies for the financial sector.
18 In this year’s World Economic Forum’s Global Competitiveness Report 2009-2010, Singapore jumped 2 places to reach 3rd spot, and remained as the highest ranked country from Asia. It was observed that Singapore’s competitiveness was propped up by a strong focus on education and training, providing highly skilled individuals for the workforce.
19 The Financial Industry Competency Standards (FICS) was developed to enhance the standards and professionalism of the financial workforce. Amidst the challenging economic environment, MAS increased the co-funding support for FICS-accredited programmes to 90% earlier this year, so as to encourage the continued development of competencies. The industry can now access 13 fund management-related FICS accredited programmes.
20 To encourage the deepening of knowledge in the fund industry, MAS also supports relevant training programmes under the Financial Training Scheme, which co-funds training costs for programmes such as the Chartered Alternative Investment Analyst (CAIA) qualification programme and the Hedge Fund Executive Education Programme.
21 In addition to competency building, MAS will continue to encourage efforts to build intellectual capital and innovative solutions through industry-academia collaboration. For the Asian markets which is still in its earlier stages of development, research will be fundamental to providing a greater understanding of the strategies, investments and a multitude of other risk factors. It is important to understand these risks and we continue to encourage research on these all areas of the markets. Three years ago, we have worked together with BNP Paribas to successfully set up the BNP Hedge Fund Centre in Singapore, with a focus on research on the Asian Hedge Fund Industry. We will continue to encourage more of such research collaborations going forward.
22 In conclusion, we do believe that the crisis can be a catalyst for transformation and work towards a more resilient and dynamic industry. If hedge funds can adapt to the new landscape well, they would be the winners of tomorrow. They are likely to be those with strong risk management culture, transparent and fair business dealings, and those who are able to adapt to a more volatile market environment.