ASIC review of hedge funds sector

The Australian Securities & Investments Commission (ASIC) has provided an overview of the Australian hedge funds sector and included in its report the results of ASIC’s 2014 hedge funds survey, which covers the 12 months to 30 September 2014. The survey was conducted partly in response to the request made by IOSCO of its members to survey their large hedge fund managers, and reflects continuing regulator interest in the sector. ASIC's 2014 hedge fund survey collected data from 18 Australian based managers (each with more than $571 million in hedge fund assets under management) and referenced 27 hedge funds which had assets under management of $37.1 billion (two of these funds were based outside of Australia).

The survey also includes separate findings from a review into the hedge funds sector based on aggregated data collected by ASIC from commercial providers.

The following sets out some key conclusions drawn from the 2014 hedge funds survey (including a comparison with the 2012 results) as described in the report:

• Size of market: Single manager hedge funds and funds of hedge funds continued to comprise a small proportion of the Australian funds management industry, managing 3.5% and 0.5% (respectively) of all Australian managed fund assets. The surveyed managers reported significant positive applications in every month of the survey year.
• The surveyed participants indicated an increase in retail participation: Direct retail investors accounted for 17% of all hedge fund investors (by NAV) and approximately 49% were retail coming in indirectly through an investor directed portfolio service. We have assisted a number of managers extend their product offering into the retail market, including by seeking to address the robust disclosure regime dictated by ASIC. Notably, the industry approach to addressing the ASIC mandated benchmark and disclosure principles were not canvassed in the survey.
• Strategy: The most common strategy employed by managers for operating single-manager hedge funds and funds of hedge funds was equity long/short (representing 56% of overall surveyed NAV).
• Asset exposure:
  • listed equities and cash were the largest net asset exposures in the survey data, at $26.3 billion and $5.7 billion respectively. This is broadly similar to the findings in 2012 and reflects the focus on long/short equity strategies by the surveyed participants.
  • Fixed interest derivatives had the largest gross market value (GMV), at $32.3 billion.¹ For this purpose, GMV is the absolute sum of the fair market value of all long and short positions. It was acknowledged however that this represented a much smaller exposure on a net basis.
  • Asset exposure to commodity derivatives fell over the review period.
• Use of leverage: While the gross leverage ratio (GNE to NAV) for surveyed hedge funds has increased since 2012 (with synthetic leverage being the largest source of leverage), the level of leverage for these funds is still relatively low compared to other jurisdictions. Synthetic leverage, primarily from collateralised borrowing via a prime broker, was the largest source of leverage and was 6 times higher than 2012 levels.
• Geographic exposure: The highest geographic exposure is now North America with 29% of NAV invested there (up from 15% in September 2012). Australia and Asia (ex-Australia) were also significant regions for the funds’ investments, with each receiving around 26% of the total NAV. Contrast this with 2012, when Australia had the largest percentage of the funds’ investments, with 38% of NAV.
• Liquidity: Most of the surveyed hedge funds said they could liquidate 89.5% of their portfolios (portfolio liquidity) in less than 30 days and could face redemptions on 81.8% of fund liabilities (investor liquidity) in less than 30 days. In 2012, 30-day portfolio liquidity was 92% and 30-day investor liquidity was 99%. All of the funds surveyed had the right to temporarily suspend investor redemptions (no fund reported having used this right in 2014). Also, unlike other jurisdictions, the surveyed funds reported negligible use of both illiquid asset side pockets and redemption gates.
• Turnover: Overall portfolio turnover was stable compared to 2012. The vast majority of turnover was in interest rate derivatives. The surveyed hedge funds did not report a wide use of high-frequency trading strategies.
• Clearing: On average, nearly 75% of derivatives volumes traded on regulated exchanges, rising dramatically from 56% in 2012. Notwithstanding recent mandated central clearing initiatives, of the 28% of derivatives that were traded over the counter, on average only 3% were cleared by central clearing counterparties.
• Performance: Annual net investment returns of surveyed hedge funds reported returns of 15.6%, compared to 5.9% for the S&P/ASX 200 Accumulation Index, and almost double and 4 times returns in 2012 and 2010 (respectively).

In conducting the surveys between 2012 and 2014, ASIC reduced the number of survey data points (mainly to assist the surveyed hedge funds in providing the relevant information in an efficient manner). Among others, these changes included adopting a broader definition of a ‘hedge fund’, in line with the definition used by IOSCO—that is, a fund that presents a combination of some of the following characteristics: (i) use of leverage, (ii) performance fees based on unrealised gains, (iii) complex strategies, which may include use of derivatives, short selling, high-frequency trading and/or the search for absolute returns, and (iv) a tendency to invest in financial rather than physical assets.

The aggregated data collected from these managers was submitted to IOSCO’s global hedge fund survey project.While the survey fits into a bigger international initiative, data collected by ASIC from the survey will inform its approach to the sector, possibly including any changes to ASIC’s mandated hedge fund disclosure principles.