Alternatives fighting to win back investors

The guilty verdict on 14 counts of insider trading against Raj Rajaratnam, former boss of the Galleon hedge funds group, should not be viewed as a damning indictment on the whole industry.

Sure, hedge funds may have been seen as a plaything for the idle rich, keen to impress peers during dinner party discussions, in a previous, pre-crisis investment era. In the days when they were secretive and could afford to turn money away, many may have been populated by the kind of adventurists keen to escape the more ordered worlds of long-only asset management and investment banking.

Traders were making a lifestyle choice. Running a hedge fund became as fashionable at the turn of the millennium as working for a dotcom group had been several years previously.

But even prior to the long running probe and subsequent court case, the $2,000bn (€1,400bn) industry has been cleaning up its act, in preparation for a looming regulatory onslaught from European, US and Asian financial authorities.

Recruitment consultants and industry practitioners both report a marked increase in the quality of people trying to enter the alternatives world, now that assets are so much more difficult to attract. Also, some of the better long-only managers looking for a more entrepreneurial outlet are now seeking backing from private equity firms and establishing boutiques for traditional asset management. This will act as another potential hoover of assets which may have previously headed for hedge funds.

Commenting on the conviction, Julian Korek, founder of Kinetic Partners, a cross-border forensic, regulatory and risk consultancy, talks about the determination of regulators to clean up markets and the efficiency of US law enforcement agencies in bringing cases to trial, aided by the threat of long prison sentences for the miscreants.

He also talks about the need for firms to be vigilant in identifying the correct use of data internally. While Mr Korek has a point, his comments generally reflect changes which have been happening for several years in the hedge fund industry.

A stark contrast between old and new mindsets is confirmed by figures from research consultancy Create, which show that prior to 2007, around 94 per cent of UK institutions had avoided hedge funds. In this non-investing majority could be found the country’s 20 largest pension schemes. And all this despite a government sponsored review conducted by Lord Myners 10 years ago, which recommended trustees open their minds to alternative investments.

But now, says Create’s CEO Amin Rajan, most of the institutions are going in. “Some are favouring the traditional, long-only group branching out into hedge funds, and others are putting money with the specialists. But risk has come firmly back on the table.”

This institutionalisation of the industry may also bode well for private wealth clients, decimated by the Madoff debacle and negative experiences with the hedge funds world in general. Will they again fall in love with the funds they were once so happy displaying to their friends as trinkets of wealth?

Platforms and fund of fund groups say there is so far little confidence of this money returning. But there is also a realisation amongst private clients that they are not going to get absolute returns from a portfolio of domestic equities. Eventually, the wall of private money must come back. The second high-profile conviction after the Madoff trial may restore a little of that confidence.