The hedge fund industry - Changes from the GFC

 

The hedge fund industry has undergone significant changes since the Great Financial Crisis (GFC), which have not received sufficient attention. The focus is usually on performance, yet it is essential to consider hedge funds as a financial industry, one that evolves and adapts to the market environment. 

Hedge funds have not really developed new ways of generating alpha. They have adopted a greater use of quantitative tools, which represents a significant innovation in enhancing existing methods for generating alpha. However, the real innovation has been the movement toward vertical integration, a widening of scope through product development, and the formalization of management structure. 

The hedge fund industry was not immune to the significant declines in returns from the financial crisis. Many firms went out of business, and many experienced severe declines in cash flows. Assets under management declined, and the expected incentive fees were reduced or eliminated. The industry had to change because the surviving focused star manager could not survive another downturn like the GFC. 

The choices were clear, no different from those in other industries that underwent upheaval. First, the innovation of the hedge fund industry was to diversify the firm's offerings. This could be the same fund but with a broader market focus. It could also be different products within the same asset class or across asset classes, or it could be some customized product with features set for a large client. Second, there was a need to gain scale and better control costs through better professional management. This could take the form of formal marketing. It could also be a separate legal and compliance department, as well as separate risk management and trading departments. 

The desire for scale and cost control meant that the small shop, with its focused manager or personality, needed to become a departmentalized, professionally managed organization. There was an end to personality and a shift to departments that focused on specific tasks, overseen by the manager/owner.

This process was observed in many other industries in the US prior to the turn of the twentieth century. This is the story of American business and its pursuit of scale and scope. The hedge fund industry is not special. It follows the pattern of other industries.