Watson Wyatt: Only Skilled Hedge Funds Will Survive

Nov 26 2008 | 12:18pm ET

Worsening market conditions and changes to the regulatory landscape will force many hedge funds to close or sell out, according to global consulting firm Watson Wyatt.

In a note to its clients, Watson Wyatt said the current crisis will expose hedge funds that are “not structured to add value for investors” and “will provide the most skilled with attractive opportunities and potential for substantial returns in the future.”

However, it added that once the smoke clears, surviving hedge fund managers will be better placed to exploit investment opportunities generated by the market dislocations and lower prices, made easier by banks' extinct proprietary trading desks.

In the long haul, end investors such as pension funds will emerge as beneficiaries of industry changes through improved fee structures. According to the firm, there are early signs pointing to hedge funds becoming more flexible in the negotiation of fees.

“While we strongly believe skilled managers should be fairly compensated, fees are generally still too high for the value they deliver, particularly as we enter a lower-return environment,” said Craig Baker, global head of manager research at Watson Wyatt.

“Also, performance fees introduced to align interests have been less than effective because they are generally poorly designed and tipped in managers' favor. For a number of years we have been trying to rectify this situation and negotiate a fairer deal on fees, but only now we are seeing real progress.”

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