Trends Watch: July 13, 2017
EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.
This week, Elana talks to Matthew Moniot, Chief Investment Officer, Elanus Capital Management.
What is your outlook for hedge funds?
Unsurprisingly for a firm that views the world through the lens of the financial system, we believe that the hedge fund model has fundamentally changed over the past decade. In particular, hedge funds are no longer the primary beneficiaries of bank balance sheet financing and liquidity provisions. Leverage, both explicit in the form of repo and margin financing and implicit in the form of derivatives, is even more costly and less accessible. For equity funds, equity dispersion is low and moves increasingly occur in discrete, (often close-to-open), moves. All of that noted, hedge funds will eventually learn how to profit from this new environment as that is what they are designed to do. However, the reputational damage will last for some time. Many allocators and traditional managers have adopted the basics of hedge fund investing, cannibalizing the least sophisticated end of the hedge fund business. Increasingly, we think success will accrue to those managers that have technological, quantitative, or fundamental expertise that cannot be replicated without spending a lot of money up front to assemble the knowledge and infrastructure.
What is your outlook for the economy?
We’ve always believed that the U.S. economy entered a relatively slow growth era once the debt-fueled boom of the 1990s ended. Productivity is low, labor force growth is low, population growth is low, global growth is low, and the government is running a deficit that cannot realistically be expanded. The upshot to all this low growth, however, is that we do not see the imbalances that we saw a decade ago. In fact, residential construction and corporate investment look as if they could continue to drive growth for several more years, making what has been a long expansion even longer. The wildcard in such an environment is cyclical booms in large EM countries, several of which are beginning to play a major role in global growth.
What keeps you up at night?
The economics of the business. We believe margins have compressed enormously over the past decade. Gross margins (revenue to AUM) of 400-600bps 15 years ago are likely 200-300bps today. Meanwhile, expenses have soared – especially fixed expenses. A fixed annual expense outlay of $5mn is likely a minimum. Fundraising has become more difficult, so marketing expenses have increased. 20 years ago they accounted for a negligible share of revenues. Today, mid-sized managers are likely spending 10-30% of revenues on marketing. Smaller managers could likely spend more than 25% of revenues on marketing. Nonetheless, allocators want lower fees – and they are justified.
Beyond the navel gazing, we worry about some of the major shifts happening in the economy. Technology is changing everything. We wonder about the “slowly and then all at once” phenomenon and what it might mean for existing assets and business models. We also worry that the same technology firms that are driving change have themselves gone well beyond anti-competitive practice. We also worry about a (well deserved?) backlash from the left and right of the political spectrum.