2009 ALTERNATIVE INVESTMENT CFO FORUM INSIGHTS

Alternative Investment CFO Forum
The 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 markets rebound, 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 Alternative Investment CFO Forum and upcoming research and events, please visit our SEI Knowledge Partnership website at www.seic.com/ims or contact your SEI Strategic Relationship Manager.

KEY TOPICS EXAMINED
STATE OF THE ALTERNATIVE INVESTMENT INDUSTRY FUND STRUCTURES: TERMS & LIQUIDITY ISSUES INSTITUTIONAL INVESTOR PERSPECTIVE REGULATORY UPDATE CHALLENGES OF RUNNING AN ALTERNATIVE FIRM

STATE OF THE ALTERNATIVE INVESTMENT INDUSTRY
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.

There are a number of drivers behind these positive forecasts, 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 continue 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 expertise focused on a long-term value add philosophy, relationships, and compensation structure to build an enduring 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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Hedge Funds 2009 was better for hedge funds than even the most optimistic 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 approach $3 trillion by year-end 2013. While 2010 hedge fund assets may be relatively flat when compared to 2009, Casey Quirk predicts that hedge fund industry revenues will recover far faster than expected.

Insights from the 2009 Alternative CFO Forum

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 industry’s assets. The Institutional Model will require more oversight and coordination with third parties. hidden or explicit. not absolute pressure to reduce. (ii) distribution. the role of the administrator will become less tactical and more strategic – a true independent partner of the firm. Meir Grossman. in order to succeed in this changed landscape. Seward & Kissel. Private equity could face some difficulty raising funds as there is a paralysis in fund raising and the LBO investment model appears stalled. and (iv) investments. Most larger fund of funds also maintain a low loan-to-value liquidity line with an investment bank or custodian. Where managed accounts were essentially the ATM for the industry. will characterize future leading and sustainable managers. The four key functions required for balance in the Institutional Model are (i) business management. – Nearly half of the surveyed managers said that they had made or plan to change liquidity terms and redemption features. not just portfolio management savvy. Third parties will play a larger role in this model through administration. custody and pricing. Overall The state of the alternative industry is not as bad as many thought it would be. holdbacks or clawbacks. responsibilities of investor relations based on requests for increased transparency and risk reporting. SEI (moderator). enhanced alignment of the fund with both investors’ liquidity needs and trader compensation. including increased use of deferrals. The rationale of the industry has changed. Mike Lee. Forty percent are changed fee structures and thirty percent made changes to both. Changes in gate structures at the investor level and interest in managed accounts by institutions are emerging. (iii) operations. Despite historically low interest rate levels. Ernst & Young.multiple prime brokers from 1-2 brokers under the Legacy Model. Meir Grossman added that “there has been an aggressive push by managers to get creative with liquidity. Liquidity concerns have led to an increase in discussions around managed accounts. However. alternative managers must institutionalize and become businesses. Liquidity and Managed Accounts Trevor Randolph addressed the shift in investor due diligence in today’s post-Madoff and post-Lehman environment. as well as expanding. Insights from the 2009 Alternative CFO Forum 2 . Management fees were reduced three times more often than performance fees. The result of this restructuring on long-term business models is an improved focus on asset/liability matching. – Fee reductions were generally linked to fund structural changes and a desire to grow assets under management. they now need to be investing side by side with funds of hedge funds. and the future opportunity for hedge funds and fund of funds is particularly attractive. 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. Private Equity The overall outlook for private equity is less bullish than that for hedge funds. that accompany this form of allocation. In addition. It’s important that fund of fund managers consider all the costs. and now banks need to pledge committed lines and perfect their security arrangements with a third-party holding the collateral. Trevor Randolph. Many mangers are making allocations to managed accounts through third party platforms. Many man- FUND STRUCTURES: TERMS & LIQUIDITY ISSUES Jim Cass. This includes making certain they maintain an appropriate liquidity profile. many fund of funds are not actively seeking leverage but rather are focused on rebalancing portfolios and strengthening their operational / due diligence procedures. Business management skills.

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. Significantly. 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. more than three out of four investors rated them as somewhat or very important in fund selection. In contrast. institutions overwhelmingly cited “poor performance” as their top worry when it came to hedge fund investing. Institutions Placed More Emphasis on Operational Quality Compliance infrastructure was ranked the third most important manager selection criterion. costs and liability depending on a manager’s current infrastructure. over 80% of the respondents reported a particular focus on funds’ valuation methodologies. Worries Over Performance Have Been Eclipsed By Other Concerns In our 2008 survey.agers are transitioning to a lock-up that lets an investor get out earlier with a pre-determined fee payment. Fee Pressures Have Intensified While fees did not rank high on the list of concerns or the manager selection criteria emphasized by survey respondents. consider different kinds of share classes and align liquidity terms with fund investments. our 2009 respondents ranked performance fifth on their list of concerns. Instead. with nearly 50% of respondents citing it as “very important. Transparency Institutional investors expect far greater information regarding their hedge fund investments. While the fundof-hedge funds model may not be revolutionized as a result of managed accounts. it will have big impacts on operations. Transparency. Diversification And Absolute Return Remain The Primary Investment Objectives These were the same primary objectives cited in SEI’s 2008 survey.” Mike Lee added that the push towards managed accounts is not a temporary phenomenon. indicating that managers would benefit from continued focus on. Insights from the 2009 Alternative CFO Forum 3 . In fact. INSTITUTIONAL INVESTOR PERSPECTIVE Phil Masterson. those surveyed named transparency as both the biggest worry and the single greatest challenge related to hedge fund investing. Only 6% of the respondents reported investing in hedge funds in order to exploit market opportunities. Thus. At the Same Time. as they were in the 2008 survey. While the type of information sought ranged from counterparty and leverage exposure data to sector and positionlevel detail. Transparency. although investors this year placed greater emphasis on achieving non-correlated returns. quality client service. respond to increased due diligence requirements. while this trend is emerging partly as a reaction to the last 12+ months. and investment in. managers will have to address transparency expectations.” Investors Continue to Look for Managers with Strong Credentials as well as a Demonstrable Source of Alpha People.” Independent administration and a separation of investment management and operations management roles were also identified as high-ranking factors in manager selection. the quality of reporting and communications as well as overall client service were ranked as equally or more important than short-term past performance. philosophy and the process for generating alpha were among top-ranked selection criteria. Institutional Investors Remain Committed Institutional investors drove hedge fund growth leading up to the financial crisis and are critical to future growth. which was led by “a lack of transparency” and “liquidity risk. SEI Phil presented the key findings from SEI’s 3rd annual survey of institutional investors regarding their hedge fund investments.

In response. which means that the SEC views the fund as the client. the relevant federal regulator would be authorized to ban any "inappropriate or risky" compensation practice that poses a threat to the financial system and the economy. The proposed rule would restrict political contribution and new business solicitation practices of investment advisers. Specifically. Hedge fund advisers are currently exempt 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. The qualified client rule would also be impacted such that if you are a registered adviser and charging a carry. "Financial institution" is defined to include investment advisers. The additional audits could become expensive and it has yet to be determined who would pay for these. a client must have a net worth of at least $1. extending beyond firms deemed to pose systemic risk. Anti-Money Laundering The Patriot Act addressed money laundering. This required data could include leverage. this custody rule will move beyond the current requirement to use a qualified custodian and provide periodic statements. 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). Systemic Risk “Systemic risk” became the catch phrase of 2009 as regulators want to require hedge fund managers to disclose data in order to assess systemic risk. The current proposal eliminates the “look through” provision. there is still tremendous pressure on the hedge fund industry to reduce what is viewed as excessive compensation. underlying positions. Compensation Proposals Even though there were no hedge fund bailouts with the 2009 TARP money. Violations of the rule would result in a 2-year ban on managing money for the relevant state or local government. In response. firms should expect additional proposals from the Treasury in 2010 around anti-money laundering as it relates to hedge funds. funds with over $150 million in assets to register with the SEC. most hedge fund managers adopted their own anti-money laundering provisions. However. banks and broker-dealers. there is a proposal to require financial institutions with more than $1 billion dollars in assets to disclose to federal regulators any incentivebased compensation structure. Insights from the 2009 Alternative CFO Forum 4 . Custody In reaction to Madoff.5 million (which would be adjusted upwards with inflation). Accredited Investor Definition The current proposal would increase the current accredited investor level for inflation and revisit the level every 2-3 years. but not specifically as it relates to hedge funds. The rule includes a regular GAAP audit at year-end and an annual surprise audit. the SEC has made it easier to issue formal orders of investigation and subpoenas. It could be considered a manager requirement or a fund expense. This is based on the “look through” provision. Under this expansive authority. in certain cases. Insider Trading The SEC suspects widespread insider trading in the hedge fund industry. not the investors.REGULATORY UPDATE Steven Nadel. and requires all investment advisers to private Pay to Play The SEC has proposed new rule aimed at eliminating “pay to play” practices by investment advisers that seek to manage assets of state and local governments. valuation practices and side letters.

The key industry trends identified include: Infrastructure Enhancements Many firms built siloed infrastructures as their businesses expanded. finance. investor and management reporting. Cost Control The majority of cost-cutting initiatives by alternative asset management firms to date have been primarily staff and compensation reductions. the road ahead and how firms are responding. The role of investor relations has also changed and it has become more of a distinct and dedicated focus for firms. Controller and Chief Accounting Officer. fund and investor accounting. The operating model has also evolved as firms are implementing a separation of CFO. There is also a growing need for firms to have dedicated technology and resources to support management. significant restructuring in fund. shareholder servicing. It is expected that firms will continue to monitor significant capital expenditures and spending will be focused around critical initiatives such as risk management. controls and overall organization to support continued growth in an increasingly complex regulatory and investor landscape. Companies are evolving from a model where all employees pitched in as needed to a more traditional model with defined roles. PricewaterhouseCoopers Tim outlined the key trends facing the alternative asset management industry. reporting requests and ongoing support. Strong risk controls will help managers provide financial information that is more accurate. More specifically. partner and investor agreements. resurgence of capital-raising efforts. compensation and nominating. Whereas this role used to focus on capital raising. many alternative asset management firms are currently focused on developing and revising their infrastructures. valuation. audit. In response to these trends. These include executive. technology and controls. – – – – – continued evolution of the alternative asset management model.CHALLENGES OF RUNNING AN ALTERNATIVE FIRM Tim Mueller. efficient and timely to better meet current and future investor expectations. 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 business objectives. risk. investment. but now firms are looking to upgrade key infrastructures to leverage common applications and functions such a CRM. tax. There is a wider range of committees than in the past. investor reporting and finance functions. Insights from the 2009 Alternative CFO Forum 5 . This structure allows for better talent and responsibility-matching. Governance and Organization The typical management structure at alternative firms is evolving and the governance structures are trending towards rationalizing board and management committee structures. investor relations is now dedicated to investor due diligence. regulatory changes. increase in investor activism and transparency. but PricewaterhouseCoopers has also seen a more diligent review of significant capital expenditures. firms are concentrating on the issues outlined below.

FOR MORE INFORMATION Visit the SEI Knowledge Partnership website at www. and develop more competitive business strategies. The SEI Knowledge Partnership is an ongoing source of action-oriented business intelligence and guidance for SEI’s investment manager clients. Insights from the 2009 Alternative CFO Forum 6 . an internal business unit of SEI. keep abreast of changing best practices. The SEI Knowledge Partnership is a service of the Investment Management Services division. It helps clients understand the issues that will shape future business conditions. This information is for educational purposes only and is not intended to provide legal or investment advice. © 2010 SEI.com/ims or contact your SEI Relationship Manager for more information on upcoming events and research. Neither SEI nor any of the quoted panelists and their firms claim responsibility for the accuracy or reliability of the data provided.seic.

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