Despite staging a comeback in many portfolios, as low yields elsewhere fuel the need for returns, hedge funds still face demands for trust, transparency and track records.
Too many funds have become obsessed with a single strategy and high leverage, thus becoming vulnerable to downturns in the economy and financial markets. "Hedge funds are supposed to be hedged. Yet, a ballooning level of beta has infected the hedge fund industry," King added.
The hedge fund industry as a whole did a poor job on diversification in the past couple of years. A look at the HFR Indices proves hedge funds were not able to avoid the downturns in 2008 and 2011, losing clients money, just as other risky assets were beaten down by volatility.
Yet, that glance might be misleading, according to Storr. They might be interesting tools for benchmarking managers, but not for investment decisions. He said: "It is way more important to pick the right manager than the right strategy."
Small managers with less than $600m assets under management might be able to offer more alpha than the big funds included in the index.
The issue of size again boils down to proper risk management on the side of the hedge fund managers, Gideon King believes. "As the inflows increase, it becomes increasingly difficult to run money safely and soundly," he said.
Pros and cons of ucits
Ucits, the regulatory framework for onshore funds, has boosted the industry, according to Storr. "It has levelled up the education of investors, as more and more funds are distributed and advertised to investors that had no exposure to hedge funds before."
Yet, Ucits funds themselves are laden with problems, ranging from higher fees to limits from the regulatory framework to the need for the manager to hold more cash to deal with redemptions. That has led to a reversal in Ucits growth lately, with more funds closing than launching.
Storr feels more comfortable in the offshore universe. One of the reasons might be the scope for diversification. Now, roughly 8,500 managers are available in the offshore universe, whereas the product range onshore amounts to 450 strategies (see chart, below).
However, Ucits - and the crisis of 2008 - changed the offshore universe too. Löwenthal said transparency and reporting standards have dramatically improved in the past couple of years, often "via the pressure of investors. Managers provide much more information today than before 2008. Investors feel more comfortable to invest."
In addition, the financial crisis has served as "a washout for rogue funds" and so left investors more certain about the legality of existing funds.