Recent Developments in the Australian Hedge Fund Industry | Bulletin – November 2006

A Reserve Bank of Australia Bulletin article from November 2006 examines the recent expansion of the Australian hedge fund industry. The RBA notes that no standard definition of a hedge fund exists, and that the term generally refers to managed funds using non-traditional strategies such as leverage, short-selling, illiquid securities and active trading, aimed at positive returns regardless of market direction. Australia's regulatory regime applies the same registration, operational and disclosure requirements to hedge funds as to other managed funds, a contrast with the United States, where hedge funds sit outside the investment management regulatory framework and are generally restricted to sophisticated investors.

Industry sources cited by the RBA put the sector at $60 billion across nearly 200 funds, compared with $45 billion a year earlier and $26 billion in 2004. The article cautions that these figures reflect funds held on behalf of investors and that market positions can be substantially larger owing to leverage. Growth has been driven by both investment inflows and reinvested returns, and has outpaced both the broader Australian managed funds industry and the global hedge fund sector.

Institutional investment has been a major driver. Endowments and foundations have long been the core investors, and Australian superannuation funds, which control over $650 billion or more than 50 per cent of national managed savings, have increased their exposure. Citing LCA Group data, the RBA notes that foreign institutional investors now supply 15 per cent of Australian hedge fund funds. The article also explains the motivations for superannuation allocations: the search for yield in a low-interest-rate environment, diversification against traditional asset classes, and dissatisfaction with index-hugging equity managers after the tech bubble. US university endowments, per NACUBO data, raised hedge fund allocations from about 2 to about 9 per cent over the past decade, with the largest endowments exceeding 20 per cent in 2005.

Despite institutional growth, individuals account for two-thirds of Australian funds under management, according to Hennessee Group and LCA Group data as at 30 June 2006. Low minimum investments, sometimes as low as $1,000 through platforms, and ten hedge funds listed on the Australian Stock Exchange with a combined market capitalisation of around $1 billion broaden retail access. Monthly trading in listed hedge fund units typically totals $15 to $20 million.

The industry is split between single-manager funds, which invest directly in markets and manage about $40 billion, and fund of funds, which invest in pools of single-manager funds and manage about $20 billion. Long-short equity is the predominant strategy among single-manager funds, accounting for over half of their assets, though most of that exposure is offshore. The RBA also observes that the line between hedge funds and traditional equity managers is narrowing, as some high-conviction managers adopt concentrated portfolios and performance fees previously associated with hedge funds, a trend Standard and Poor's has also noted. Established financial institutions are increasingly offering hedge fund products.