Plugin-2009 CFO Forum Exec Summ

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Insights from the 2009 Alternative CFO Forum 1

2009 ALTERNATIVE INVESTMENT CFO FORUM INSIGHTS

Alternative Investment CFO ForumThe financial crisis and dramatic scandals of 2008 combined to significantly alter the investment management landscape.In order to help our alternative investment manager clients position their firms to capitalize on opportunities as marketsrebound, SEI gathered premier industry analysts and practitioners at our first annual Alternative Investment CFO Forum.

The key insights and guidance from the Forum are highlighted below. For more information about the 2009 AlternativeInvestment CFO Forum and upcoming research and events, please visit our SEI Knowledge Partnership website atwww.seic.com/ims or contact your SEI Strategic Relationship Manager.

K E Y T O P I C S E X A M I N E D

S T A T E O F T H E A L T E R N A T I V E I N V E S T M E N T I N D U S T R Y

F U N D S T R U C T U R E S : T E R M S & L I Q U I D I T Y I S S U E S

I N S T I T U T I O N A L I N V E S T O R P E R S P E C T I V E

R E G U L A T O R Y U P D A T E

C H A L L E N G E S O F R U N N I N G A N A L T E R N A T I V E F I R M

S T A T E O F T H E A L T E R N A T I V E

I N V E S T M E N T I N D U S T R Y

Daniel Celeghin, Casey Quirk

Daniel discussed four themes: (i) disaster averted, (ii)

hedge funds remain a growth industry, (iii) new relevance of

non-investment functions, and (iv) alignments within firms

and with investors really matter.

Hedge Funds

2009 was better for hedge funds than even the most opti-mistic predictions. Total hedge fund assets reached $1.5

trillion by third quarter 2009 and Casey Quirk estimates that

total assets under management for hedge funds will ap-

proach $3 trillion by year-end 2013. While 2010 hedge fund

assets may be relatively flat when compared to 2009, Ca-

sey Quirk predicts that hedge fund industry revenues will

recover far faster than expected.

There are a number of drivers behind these positive fore-

casts, most notably a change in investor perception about

the importance of adding hedge strategies to a traditionally

long-only portfolio. Fund of hedge funds should also con-

tinue to be a key distribution channel as most FOHFs

avoided Madoff-like issues and add a layer of due diligence

and investment expertise.

Managers are realizing that non-investment functions will

have an ever-greater role in a successful firm. Many firms

are shifting from what Casey Quirk calls the Legacy Model

to the Institutional Model. Where the Legacy Model was

focused primarily on a single area of expertise, short-term

sales, product development and compensation structure,

the Institutional Model shifts towards multiple areas of ex-

pertise focused on a long-term value add philosophy,

relationships, and compensation structure to build an en-

during firm.

Casey Quirk expects that third parties such as custodians

and administrators will play a bigger role in firm operations

in the Institutional Model because firms will move towards


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multiple prime brokers from 1-2 brokers under the Legacy

Model. In addition, the role of the administrator will become

less tactical and more strategic a true independent part-

ner of the firm. The Institutional Model will require more

oversight and coordination with third parties.

The four key functions required for balance in the Institu-

tional Model are (i) business management, (ii) distribution,

(iii) operations, and (iv) investments. Third parties will play

a larger role in this model through administration, custody

and pricing.

Private Equity

The overall outlook for private equity is less bullish than that

for hedge funds. Private equity could face some difficulty

raising funds as there is a paralysis in fund raising and the

LBO investment model appears stalled.

Overall

The state of the alternative industry is not as bad as many

thought it would be, and the future opportunity for hedge

funds and fund of funds is particularly attractive.

However, in order to succeed in this changed landscape,

alternative managers must institutionalize and become

businesses. Business management skills, not just portfolio

management savvy, will characterize future leading and

sustainable managers.

F U N D S T R U C T U R E S : T E R M S & L I -

Q U I D I T Y I S S U E S

Jim Cass, SEI (moderator); Mike Lee, Ernst & Young; Meir

Grossman, Seward & Kissel; Trevor Randolph, Credit

Suisse

Mike Lee began the panel discussion by identifying key

findings from a Fall 2009 Ernst & Young survey of 100

hedge fund executives representing about half of the indus-

trys assets.

Nearly half of the surveyed managers said that

they had made or plan to change liquidity terms

and redemption features. Forty percent are

changed fee structures and thirty percent made

changes to both.

Fee reductions were generally linked to fund struc-

tural changes and a desire to grow assets under

management, not absolute pressure to reduce.

Management fees were reduced three times more

often than performance fees.

The result of this restructuring on long-term business mod-

els is an improved focus on asset/liability matching,

enhanced alignment of the fund with both investors liquidity

needs and trader compensation, including increased use of

deferrals, holdbacks or clawbacks. Changes in gate struc-

tures at the investor level and interest in managed accounts

by institutions are emerging, as well as expanding, respon-

sibilities of investor relations based on requests forincreased transparency and risk reporting.

Liquidity and Managed Accounts

Trevor Randolph addressed the shift in investor due dili-

gence in todays post-Madoff and post-Lehman

environment. Despite historically low interest rate levels,

many fund of funds are not actively seeking leverage but

rather are focused on rebalancing portfo-

lios and strengthening their operational / due diligence

procedures. This includes making certain they maintain an

appropriate liquidity profile. Many mangers are making al-

locations to managed accounts through third party

platforms. Its important that fund of fund managers con-

sider all the costs, hidden or explicit, that accompany this

form of allocation. Most larger fund of funds also maintain a

low loan-to-value liquidity line with an investment bank or

custodian. These types of facilities are generally secured

by the fund of funds' hedge fund investments and require

that the hedge fund investments are registered with a third

party custodian similar to SEI.

Liquidity concerns have led to an increase in discussions

around managed accounts. Where managed accounts

were essentially the ATM for the industry, they now need to

be investing side by side with funds of hedge funds. The

rationale of the industry has changed, and now banks need

to pledge committed lines and perfect their security ar-

rangements with a third-party holding the collateral.

Meir Grossman added that there has been an aggressive

push by managers to get creative with liquidity. Many man-


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agers are transitioning to a lock-up that lets an investor get

out earlier with a pre-determined fee payment.

Mike Lee added that the push towards managed accounts

is not a temporary phenomenon. Instead, while this trend is

emerging partly as a reaction to the last 12+ months, it will

have big impacts on operations, costs and liability depend-

ing on a managers current infrastructure. While the fund-

of-hedge funds model may not be revolutionized as a result

of managed accounts, managers will have to address

transparency expectations, respond to increased due dili-

gence requirements, consider different kinds of share

classes and align liquidity terms with fund investments.

I N S T I T U T I O N A L I N V E S T O R

P E R S P E C T I V E

Phil Masterson, SEI

Phil presented the key findings from SEIs 3rd annual survey

of institutional investors regarding their hedge fund invest-

ments.

Institutional Investors Remain Committed

Institutional investors drove hedge fund growth leading up

to the financial crisis and are critical to future growth. Thus,managers may find encouragement that nearly 80% of all

survey respondents said they have no plans to change their

hedge fund allocations in the next 12 months while 15%

expect to increase their allocations.

Diversification And Absolute Return Remain The Primary

Investment Objectives

These were the same primary objectives cited in SEIs 2008

survey, although investors this year placed greater empha-

sis on achieving non-correlated returns. Only 6% of the

respondents reported investing in hedge funds in order toexploit market opportunities.

Transparency, Transparency, Transparency

Institutional investors expect far greater information regard-

ing their hedge fund investments. In fact, those surveyed

named transparency as both the biggest worry and the sin-

gle greatest challenge related to hedge fund investing.

While the type of information sought ranged from counter-

party and leverage exposure data to sector and position-level detail, over 80% of the respondents reported a particu

lar focus on funds valuation methodologies.

Worries Over Performance Have Been Eclipsed By Other

Concerns

In our 2008 survey, institutions overwhelmingly cited poor

performance as their top worry when it came to hedge fund

investing. In contrast, our 2009 respondents ranked per-

formance fifth on their list of concerns, which was led by a

lack of transparency and liquidity risk.

Investors Continue to Look for Managers with Strong Cre-dentials as well as a Demonstrable Source of Alpha

People, philosophy and the process for generating alpha

were among top-ranked selection criteria, as they were in

the 2008 survey. Significantly, the quality of reporting and

communications as well as overall client service were

ranked as equally or more important than short-term past

performance, indicating that managers would benefit from

continued focus on, and investment in, quality client ser-

vice.

At the Same Time, Institutions Placed More Emphasis onOperational Quality

Compliance infrastructure was ranked the third most impor-

tant manager selection criterion, with nearly 50% of

respondents citing it as very important. Independent ad-

ministration and a separation of investment management

and operations management roles were also identified as

high-ranking factors in manager selection.

Fee Pressures Have Intensified

While fees did not rank high on the list of concerns or the

manager selection criteria emphasized by survey respon-

dents, more than three out of four investors rated them as

somewhat or very important in fund selection. Nearly one

in five respondents reported negotiating fee arrangements

different than the standard 2/20 for single-manager funds

and 1/10 for FOHFs over the last year.


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R E G U L A T O R Y U P D A T E

Steven Nadel, Seward & Kissel

SEC Registration

The largest regulatory issue affecting the alternative asset

management industry is hedge fund adviser registration as

an investment adviser with the Securities and Exchange

Commission (SEC). Hedge fund advisers are currently ex-

empt from this registration requirement as long as they do

not have more than 14 clients and are not positioned to the

public as an investment adviser. This is based on the look

through provision, which means that the SEC views the

fund as the client, not the investors.

The current proposal eliminates the look through provi-

sion, and requires all investment advisers to private

funds with over $150 million in assets to register with the

SEC.

Systemic Risk

Systemic risk became the catch phrase of 2009 as regula-

tors want to require hedge fund managers to disclose data

in order to assess systemic risk. This required data could

include leverage, underlying positions, valuation practices

and side letters.

Accredited Investor Definition

The current proposal would increase the current accredited

investor level for inflation and revisit the level every 2-3

years. The qualified client rule would also be impacted

such that if you are a registered adviser and charging a

carry, a client must have a net worth of at least $1.5 million

(which would be adjusted upwards with inflation).

Custody

In reaction to Madoff, this custody rule will move beyond the

current requirement to use a qualified custodian and pro-

vide periodic statements. The rule includes a regular GAAP

audit at year-end andan annual surprise audit, in certain

cases.

The additional audits could become expensive and it has

yet to be determined who would pay for these. It could be

considered a manager requirement or a fund expense.

Pay to Play

The SEC has proposed new rule aimed at eliminating payto play practices by investment advisers that seek to man-

age assets of state and local governments. The proposed

rule would restrict political contribution and new business

solicitation practices of investment advisers. Violations of

the rule would result in a 2-year ban on managing money

for the relevant state or local government.

Insider Trading

The SEC suspects widespread insider trading in the hedge

fund industry. In response, the SEC has made it easier to

issue formal orders of investigation and subpoenas.

Compensation Proposals

Even though there were no hedge fund bailouts with the

2009 TARP money, there is still tremendous pressure on

the hedge fund industry to reduce what is viewed as exces-

sive compensation. Specifically, there is a proposal to

require financial institutions with more than $1 billion dollars

in assets to disclose to federal regulators any incentive-

based compensation structure. Under this expansive au-

thority, extending beyond firms deemed to pose systemic

risk, the relevant federal regulator would be authorized toban any "inappropriate or risky" compensation practice that

poses a threat to the financial system and the economy.

"Financial institution" is defined to include investment ad-

visers, banks and broker-dealers.

Anti-Money Laundering

The Patriot Act addressed money laundering, but not spe-

cifically as it relates to hedge funds. In response, most

hedge fund managers adopted their own anti-money laun-

dering provisions. However, firms should expect additional

proposals from the Treasury in 2010 around anti-moneylaundering as it relates to hedge funds.


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C H A L L E N G E S O F R U N N I N G A N

A L T E R N A T I V E F I R M

Tim Mueller, PricewaterhouseCoopers

Tim outlined the key trends facing the alternative asset

management industry, the road ahead and how firms are

responding. The key industry trends identified include:

continued evolution of the alternative asset man-

agement model;

increase in investor activism and transparency;

regulatory changes;

resurgence of capital-raising efforts;

significant restructuring in fund, partner and inves-

tor agreements.

In response to these trends, many alternative asset man-

agement firms are currently focused on developing and

revising their infrastructures, controls and overall organiza-

tion to support continued growth in an increasingly complex

regulatory and investor landscape. More specifically, firms

are concentrating on the issues outlined below.

Governance and Organization

The typical management structure at alternative firms isevolving and the governance structures are trending to-

wards rationalizing board and management committee

structures. There is a wider range of committees than in

the past. These include executive, investment, audit, fi-

nance, risk, valuation, compensation and nominating.

Companies are evolving from a model where all employees

pitched in as needed to a more traditional model with de-

fined roles. This structure allows for better talent and

responsibility-matching.

The operating model has also evolved as firms are imple-

menting a separation of CFO, Controller and ChiefAccounting Officer. There is also a growing need for firms

to have dedicated technology and resources to support

management, investor reporting and finance functions.

The role of investor relations has also changed and it has

become more of a distinct and dedicated focus for firms.

Whereas this role used to focus on capital raising, investor

relations is now dedicated to investor due diligence, report-

ing requests and ongoing support.

Infrastructure Enhancements

Many firms built siloed infrastructures as their businessesexpanded, but now firms are looking to upgrade key infra-

structures to leverage common applications and functions

such a CRM, shareholder servicing, fund and investor ac-

counting, tax, investor and management reporting.

Information is integral to an alternative asset management

firm and a central information management capability is

necessary to meet growing information needs.

Control Assessment & Enhancement

Reducing operational risk by developing a robust control

environment around key processes provides the opportunity

for a firm to better manage its key risks and meet its busi-

ness objectives. Strong risk controls will help managers

provide financial information that is more accurate, efficient

and timely to better meet current and future investor expec-

tations.

Cost Control

The majority of cost-cutting initiatives by alternative asset

management firms to date have been primarily staff and

compensation reductions, but PricewaterhouseCoopers has

also seen a more diligent review of significant capital ex-

penditures.

It is expected that firms will continue to monitor significant

capital expenditures and spending will be focused around

critical initiatives such as risk management, technology and

controls.


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F O R M O R E I N F O R M A T I O N

Visit the SEI Knowledge Partnership website at

www.seic.com/ims or contact your SEI Relationship Man-

ager for more information on upcoming events and

research. The SEI Knowledge Partnership is an ongoing

source of action-oriented business intelligence and guid-

ance for SEIs investment manager clients. It helps clients

understand the issues that will shape future business condi-

tions, keep abreast of changing best practices, and develop

more competitive business strategies.

The SEI Knowledge Partnership is a service of the Invest-

ment Management Services division, an internal businessunit of SEI.

This information is for educational purposes only and is not

intended to provide legal or investment advice. Neither SEI

nor any of the quoted panelists and their firms claim re-

sponsibility for the accuracy or reliability of the data

provided. 2010 SEI.

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