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Publisher: Informa.
Price: £695.00



This report:

Includes a practical guide to setting up a hedge fund as outlined by a leading investment bank


Covers all major groups of participants

Reveals what people are really thinking


Contextualises the industry

Anticipates future developments
















Bayard Partners

A successful UK-based hedge fund

Over the last two calendar years Bayard Partners has run a European equity hedge fund that has been among the top-performing European-based funds. As a consequence their profile has been raised through media coverage and fund of funds managers act like they have a right of access to the managers. This case study answers the questions: ‘How has Bayard reacted to the new challenges?’ and ‘What has growth and success done for the partnership?’



Strategic Focus on European Hedge Funds

The executive brief will set the context and thus also establish the rationale for the European Hedge Funds report, before extracting highlights from each chapter and drawing some conclusions.


The global hedge fund industry is dominated by America: the largest funds are American, the majority of funds by number are in America and a large part of the money invested comes from American investors. Europe has traditionally been seen solely as a source of funds for American hedge fund managers. Wealthy European investors, whose money had been managed out of Switzerland, got involved at an early stage in the Quantum and Tiger funds and there has been increasing involvement in hedge funds ever since. The European-based hedge funds have been something of a side-show to the main event in the United States. They were small in number and in assets under management and, worse, were perceived as being flaky compared to their American peers.

None of these former perceptions of European-based hedge fund managers is true any longer. The fund-of-funds sector in Europe may have been more extensively developed over a longer period of time than the local management of individual hedge funds, but the European-based hedge fund sector is catching up quickly. Over recent years there has been a dramatic increase in the number of hedge funds managed in Europe. The assets under management have expanded at a faster rate.

Seemingly, the European hedge fund industry has skipped a few stages of development and is developing signs of maturity even now. There is an infrastructure in place to support the commercial potential of hedge funds as clients of other services. Specialist consultants, software suppliers, recruitment specialists, legal services, administrative capacity and outsourcing capabilities have all sprung up in Europe in the last few years as the industry has hit a critical mass to sustain these businesses.

Just as hedge funds generally are the leading edge of investment and trading techniques, so it is increasingly observed that the European element of the hedge fund industry is the leading edge of its growth. The European hedge fund industry has become so dynamic as to represent a real threat to traditional asset management companies and great growth opportunity to investment banks with European operations.

To complete the turning of the wheel, American capital is now flooding into European hedge funds as the attractions of Europe have become irresistible. The giants of the American hedge fund industry are setting up in London to fulfil the maxim of ‘think global, act local’. The creation of the euro and the realisation of the potential of the EU’s single market has got the owners of American capital truly excited. A great comfort for them is their perception that Europe is in the throes of adopting American capitalism wholesale.

These developments make a research-based report on the European hedge fund industry a timely publication. The research for the report was conducted over the period February to August 1999. Over 40 hedge funds in Europe either participated in the fact-finding, responded to the questionnaire or gave interviews. In addition, more than a dozen multi-manager hedge fund advisory firms gave their input. In total more than 100 hedge fund industry professionals from Europe and the United States contributed to the research for this report.

The report puts into perspective the trends and developments happening now and it is the first attempt to analyse in depth the European sphere of the hedge fund industry. The report is pitched at those with some knowledge of or exposure to, the hedge fund industry, so a reader is as likely to be in the finance sector as in the hedge fund industry itself. The inclusion of a historical perspective and a glossary of terms will allow those with less initial knowledge to read the rest of the report secure in the basics of the industry.

The discrete nature of the industry and its clients has kept from common view the sweeping changes in the European hedge fund industry of the last five years. This report highlights the trends that have developed over that time and gives examples that illustrate the trends.


A reader of the report will:

  • Understand the dynamics driving the growth of the hedge fund industry in Europe
  • Know the steps involved in setting up a hedge fund in Europe and be aware of the pitfalls
  • Appreciate which styles of investment have been in favour and which will be favoured in future
  • Understand the significance and breadth of American interest in European hedge funds
  • Know what effects the LTCM crisis had on the hedge fund industry and what has driven the regulatory concerns in regard to hedge funds

Chapter 1: a hedge fund primer
Chapter 2: characteristics of the european hedge fund industry
Chapter 3: starting a hedge fund
Chapter 4: investors in hedge funds
Chapter 5: fund of funds managers
Chapter 6: investing institutions and hedge funds

Chapter 7: Connecticut comes to Surrey

Chapter 8: the environment for hedge funds post the LTCM crisis
Chapter 9: banks, hedge funds and regulators
Chapter 10: the cutting edge of the European hedge fund industry

Case studies


Highlights and salient points by chapter

Chapter 1: a hedge fund primer

This chapter is intended to allow those with a general interest in financial markets to understand what distinguishes hedge funds form other forms of collective investment. The explanations given allow those not greatly familiar with hedge funds to begin to see how experienced investors differentiate between funds.

The chapter covers the following areas:

  • A short history of hedge funds outlining the five phases of development
  • The six defining characteristics of hedge funds. These are listed and explained along with their secondary features. A reference is made to comparisons between CTAs and hedge funds
  • The universe of hedge funds can be divided in many different ways. This chapter details how observers of the industry categorise the funds, and gives brief descriptions of the most commonly used strategies (styles)
  • The phenomenon of style drift and its significance

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Chapter 2: characteristics of the european hedge fund industry

The global hedge fund industry has enjoyed robust growth, benefiting from an explosion of wealth. A tenfold increase to over $1.7 trillion in assets is expected for the global industry over the next nine years. Given the patterns of supply and demand in place over the past few years it is reasonable to expect the European hedge fund industry to more than keep pace with the growth rates expected for the whole hedge fund industry. There has grown to be a better balance between European-based investors and an indigenous investment advisor community, as the latter has multiplied rapidly – the number of European hedge funds rose by 27 per cent in the first six months of 1999 alone. Supporting the expansion in the number of European-based hedge funds has been a flowering of services to hedge funds centred in London and Dublin.

Chapter 2 concludes that:

  • There has been a good growth in assets under management in European-based hedge funds over recent years – from $3.8 billion in January 1994 to $12.5 billion in July 1999 – though the build-up in capital has not been a smooth progression
  • The universe of European managers eligible to most fund of funds managers will expand aggressively over the next few years as more of the managers reach common thresholds such as a two or three-year track record. This will stimulate new demand
  • In Europe two-thirds of hedge funds are in equity styles, and two-thirds of those are in European equity hedge funds. There has not been the broad spread of styles available in Europe that exists in the United States
  • Perceptions of European-based hedge funds have been changed by three developments: there was a solid performance by the average European fund in the market turmoil of 1998; European equity style hedge funds were the best-performing style in 1998; several European-based managers have risen to prominence in performance rankings, so improving the tone of industry news-flow on Europe
  • Dublin is fast assuming the role of the European centre for hedge fund administration and listing, partly through a particularly constructive responsiveness from the regulatory authorities. Hedge funds are listing in Dublin at the rate of more than a hundred a year. Global administrators like Hemisphere have set up in Dublin because they wanted exposure to the ‘burgeoning hedge fund market in Europe’
  • The lack of growth in assets in offshore hedge funds administered in Guernsey may be due to a global large-size effect and/or a lack of growth in multi-manager funds

Chapter 3: starting a hedge fund

This chapter has highlighted the issues that must be considered when starting a hedge fund.The IMRO criteria for authorising a fund management company seeking to establish a hedge fund are strict but, if met, allow a unique opportunity to gain financial reward and personal satisfaction. In parallel with this process the hedge fund manager faces many crucial decisions when setting up the hedge fund, all of which will have a significant impact on the way the hedge fund is run, managed and, in turn, how it performs. The issues detailed are raising capital from investors, marketing the fund to attract such investment and selecting the service providers who will effectively act as business partners (these include the offshore administrator and the prime broker). The chapter concludes by showing that timing and planning are key elements in starting a hedge fund. The planning must involve not only the key decisions discussed above but also the non-business, tangible factors concerning the office and technology.

Chapter 3 concludes that:

  • Setting up a hedge fund is complex, time-consuming but hopefully ultimately rewarding
  • Hedge fund managers are not alone and can draw on the service providers for support during and after the start-up phase
  • A well-structured approach will lead to smooth running and efficiency, which increase the chances of creating a successful hedge fund

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Chapter 4: investors in hedge funds

This chapter looks at investors in hedge funds: into what sort of groups they fall, and which are the most significant to the industry. It also includes a practical section of pointers for hedge fund investors.

The chapter draws the following conclusions:

  • In 1998 the hedge fund industry grew by 5 per cent. The last time that leveraged bond plays caused problems, in 1994, the industry declined 17 per cent over the year. So over the course of the intervening four or five years, investors have learned valuable lessons
  • In contrast to American investing institutions, there is a fear among European institutions that their hedge fund investing may be perceived poorly
  • Over 80 per cent of the capital invested in hedge funds has been contributed by private investors. Allocations to hedge funds from the different types of investors vary from a small percentage to a very small percentage of total assets
  • Low-leveraged arbitrage-type strategies in particular, and conservatively structured funds-of-funds may be of interest to investors looking for returns to beat short rates over a minimum period measured in months. These sorts of approaches have been used by corporate treasurers and some charities in Europe
  • As hedge fund investors, family offices are stylistically and attitudinally somewhere between HNWIs and investing institutions. A recent trend has been for European-based family offices to take more direct interest in hedge funds
  • In the industry environment post the LTCM crisis the investor has more clout than previously, so investors should demand reforms where they are necessary

Chapter 5: fund of funds managers

The first part of this chapter is structured around the major tasks of a fund of funds (FoF) manager, where possible using European FoF managers to illustrate features. The patterns of activity follow those for any service industry – understand what the client wants, provide the service and then follow up. The second part of the chapter covers issues surrounding the use of FoF managers. FoF managers commonly offer a range of ancillary services; this chapter covers the range of such services and discusses potential conflicts of interest. The advantages of using a FoF manager are covered, as is how some managers really earn the fees levied. Finally, some thought is given to the prospects for FoF managers. Leading questions to ask FoF managers are included in the text and some practical advice is offered to investors either using FoFs now or considering doing so.

Chapter 5 concludes that:

  • New patterns of demand are emerging as institutional investors have become investors in hedge funds. FoF managers are well placed to take advantage of these new flows of capital from investors who often know little of this specialised area of investment
  • The extra layer of fees for a fund selector needs to be justified. The quality of the investment management decisions and the resulting risk/return characteristics are some of the tests to apply in deciding whether to use a FoF manager. In the period before the LTCM crisis some FoF managers proved the point by avoiding leverage bond strategies altogether
  • Some of the oldest funds of funds in the world are of European origin, so the fund of funds sector in Europe is more developed than the asset management sector in the hedge fund industry
  • With hedge fund data becoming a commodity, and analytical tools being readily available, the true added value of FoF managers is in the qualitative assessment of managers
  • FoF managers vary greatly in their manner of operation. The FoF manager selected by an investor should either offer a knowledge or skill-base complementary to their own, or carry out the tasks the investor would, given the time and resources
  • The more different capacities in which a FoF manager acts, the more potential there is for conflicts of interest

Chapter 6: investing institutions and hedge funds

Investments in hedge funds from European institutional investors will grow aggressively from a small base for some years. This will fuel growth of hedge fund related consultancy work from institutions willing to recognise that they do not have the specific knowledge to set up programmes to invest in the funds directly themselves. The manner of operation of investing institutions will frustrate participants in the faster moving hedge fund world, but the size of the potential mandate will keep the sell side engaged.

Chapter 6 concludes that:

  • Investing institutions have a clear idea of what they want from hedge fund investments centred on diversification benefits, but also informational benefits
  • Transparency has become a hot issue for institutional investors. The industry has to create new mechanisms so that the transmission of information about portfolio holdings does not threaten the proprietary nature of the investment itself
  • Institutions will focus initially nearly exclusively on market-neutral strategies. The corollary is that the client bases of market-neutral funds will become dominated by institutional investors. Market-neutral funds in their appeal to institutions are a Trojan horse for all other strategies of hedge funds
  • Hedge fund investing does not fit the pattern of prevailing activity at institutional investors. This means institutions and their advisors have an additional workload requiring rare experience and knowledge. An infrastructure will have to be put in place and resources will have to be committed to make the investment programmes successful
  • ‘Institutional money flows into hedge funds at the moment could be seen as the smart money, and that will become the big money over the next few years’

Chapter 7: Connecticut comes to Surrey

The last decade has seen not just the triumph of capitalism in former socialist economies, but an emerging hegemony of American capitalism so naturally, the American influence on developments in the European hedge fund sector has been strong. Admittedly, there has been some traffic the other way but essentially hedge funds are American. This chapter is about the transplanting of American hedge fund concepts, capital and people to Europe. For the hedge fund sector in Europe the key imports of the American investment banking business have been prime broking and corporate finance.

Chapter 7 draws the following conclusions:

  • The combination of the global triumph of American capitalism and the creation of the single market in the EU will make European industries subject to Anglo-Saxon style corporate financial methods. This dynamic environment is a fertile feeding ground for hedge fund strategies and that has been recognised and acted upon by American hedge fund investors
  • American investors investing in European-based hedge funds and American hedge funds investing in Europe have expressed a strong preference for market-neutral and arbitrage-type strategies
  • American fund of funds managers are making a conscious effort to increase their knowledge of the European financial markets and European-based hedge fund managers
  • The operation of London and/or European offices by American hedge funds has entered a second phase. The pioneers are well integrated locally and they have both research and trading capability in Europe. The newer arrivals tend to start with a research focus

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Chapter 8: the environment for hedge funds post the LTCM crisis

It is clear that many participants in the hedge fund industry were shocked by the events of last year. In this part of the report some of the changes in attitude that came out of that state of shock, and the altered approaches adopted by investors are outlined.

The chapter draws the following conclusions:

  • The market events of 1998 exposed the risks that were being taken by hedge funds and, consequently, hedge fund managers discovered the true risk tolerances of banks, prime brokerages and investors. There were shifts away from hedge fund-related activity altogether towards less risk-assuming forms of hedge fund exposures for those that stayed in
  • Investing in hedge funds has become less of a sellers’ market and more of a buyers’ market. This has resulted in changes in attitude towards disclosure of information
  • Lending to hedge funds was restricted in the period after the LTCM crisis and marginal lenders ceased that line of business. Credit was still available to funds that were not leveraged very much
  • The avoidance of loss and low volatility of return became higher priorities for many hedge fund managers. The corollary was that risk control and risk management became more important to them
  • Liquidity has assumed more importance for most participants in the hedge fund industry. For hedge fund managers and prime brokers the liquidity in the underlying investments has become more important. For investors in hedge funds, fund of funds managers, and those banks that engage in structuring of hedge fund products it is liquidity of dealing in the funds themselves that has become more of a focus of attention
  • Prime brokers will play an increasing role in the production and dissemination of analysis related to hedge fund risk. Hedge fund investors and fund of funds managers will be beneficiaries of this increased transparency


Chapter 9: banks, hedge funds and regulators

The relationship between banks and hedge funds is a complex one. The significance of hedge funds to banks generally, and to investment banks specifically, is examined. The pivotal role of the prime brokerage function is discussed. The LTCM crisis brought the commercial relationships to public attention – indeed they became a matter of public policy. The key regulatory developments that followed from the collapse of LTCM are highlighted; the explicit threat of direct regulation of hedge funds hangs heavy in the air. The dynamic environment for hedge funds in Europe is very much a function of changing strategies of banks in Europe; typical bank involvement is discussed.

The chapter draws the following conclusions:

  • Hedge funds are very important clients and counterparties to banks. The funds are the largest client group in some significant business streams and they dominate the most sophisticated strategies. As bank clients, hedge funds are unique in their ability to take on the risks that other financial market participants seek to hedge
  • Prime brokerage is recognised as a key business area by banks with capital markets ambitions. Business from hedge funds is seen by bank managements as desirable, and that brings its own pressure and consequences
  • Bank risk management processes must improve in regard to business with ‘Highly Leveraged Institutions’
  • Hedge funds have to improve their degree of disclosure to their bank counterparties
  • If these two improvements aren’t seen to be enough to curtail systemic risk to the financial markets from hedge funds, then hedge funds will be directly regulated
  • The strategic shifts in investment banking in Europe have led to the dynamic growth in the number of hedge funds in Europe

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Chapter 10: the cutting edge of the European hedge fund industry

This chapter captures what is at the cutting edge of hedge fund activity in Europe in several areas and looks for emerging trends. The signs of change are examined for future implications in areas such as the distribution of hedge funds via fund of funds managers, in the investment styles of emerging managers and in the potential for growth in demand. The market views of a couple of experienced hedge fund managers are studied in order to focus on the question of what styles of investment will perform well in the European context expected. The exciting potential within the European fixed income markets is covered specifically.

The chapter concludes that:

  • The European part of the hedge fund industry has acquired such a momentum that it is unlikely to deviate from its growth track except in the event of a prolonged bear phase in financial markets
  • The current size and dynamism of the industry is such that it supports new business models for the launch of new hedge funds, including funds sponsored by former employers
  • The performance of European-based hedge fund managers in the third quarter of 1998 has changed expectations of how they will perform in adverse market circumstances in future
  • The first half of 1999 gave a strong sign of increasing maturity of the European end of the hedge fund industry as European equity long/short funds were not the dominant style of newly launched funds. The universe of European-based funds managers will encompass a greater range of styles in future
  • The level of demand for European-based hedge funds is reflected in the soaring distribution of EuroHedge Update, the specialist publication dedicated to the industry, as well as in the raising of $1.5 billion for new funds in the year to date (August 1999)
  • The changes in the patterns of demand for hedge funds will maroon some fund of funds managers at their current size
  • Pragmatic hedge fund managers, global macro funds and fixed-income funds have particularly good opportunities in anticipated market conditions

Findings related to the Key Issues are as follows:

  • Understand the dynamics driving the growth of the hedge fund industry in Europe
  • Proprietary trading is being outsourced to hedge funds, sometimes as a commercial strategy, sometimes on an involuntary basis
  • The European-based hedge fund industry has gained commercial momentum (critical mass x forward motion). Consequently, there is a clear path to follow in setting up a hedge fund in Europe

  • Appreciate which styles of investment have been in favour and which will be favoured in future
  • Long/short European equity funds have been the dominant investment style of European-based hedge funds
  • Arbitrage-type strategies are now increasingly in demand
  • Fixed-income hedge funds and global macro strategies will be of more interest later

  • Understand the significance and breadth of American interest in European hedge funds
  • American finance professionals see Europe as a region ripe for exploitation as existing markets mature and new markets open up in sectors previously found only in the US
  • American investors in hedge funds, having largely ignored funds based in Europe, have begun to actively seek them out. This is a major source of new demand
  • The managers of the larger American hedge funds have strategically shifted from investing in European markets from an American base. A first stage is to set up a research presence in Europe. Later, trading operations are added to invest in European markets from a capability in the region, usually in London. The trading operations have become significant players in markets locally

  • Know what effects the LTCM crisis had on the hedge fund industry and what has driven the regulatory concerns in regard to hedge funds
  • The regulators of the financial sector are ultimately concerned that hedge funds should not be able to pose systemic risks
  • Should investment banks (rather than commercial banks) carry out improved due diligence and monitoring of risks associated with hedge funds then regulators will not seek to directly regulate hedge funds
  • The price to be paid by hedge funds to enable them to continue to operate without direct regulation is that they must increase information flows to their clients and, in particular, to their bank counterparties
  • Risk assumption in all forms has been curtailed in hedge funds. Leverage has dropped both because credit has not been as readily available, and also as hedge fund managers drew in their own horns. Investors moved capital to funds with less risky strategies

Case studies

The case studies have been selected to reflect hedge funds at different stages of their lifecycle and to address issues from the varied perspectives of those operating in different sectors of the industry. In contributing to the case studies, each company was asked to comment on the effects of the LTCM crisis on their area of activity and on the effects that they observed on hedge funds.

Bayard Partners

A successful UK-based hedge fund
Over the last two calendar years Bayard Partners has run a European equity hedge fund that has been among the top-performing European-based funds. As a consequence their profile has been raised through media coverage and fund of funds managers act like they have a right of access to the managers. This case study answers the questions: ‘How has Bayard reacted to the new challenges?’ and ‘What has growth and success done for the partnership?’

International Fund Marketing (UK) Limited

A contract marketing organisation
The role of contract marketers is not well understood. This case study gives an overview of the work it entails and looks at the impact of the LTCM crisis on marketing.

Financial Risk Management Ltd

A UK-based fund of funds manager and consultancy
Funds of funds play a pivotal role in the hedge fund industry, acting as a knowledgeable interface between hedge funds and their investors. This case study looks at the approach of one of London’s best-regarded FoF managers. In particular, attitudes and measures of risk are discussed. The added value that a FoF brings to hedge fund assessment emerges from consideration of the tasks the activity requires.

Global Fund Analysis

A UK-based multi-manager investment consultant best known for publishing hedge fund research
Global Fund Analysis (GFA) is a research house that specialises in analysis of offshore funds. The vantage-point that GFA has is similar to a fund of funds – seeing a lot of different styles and many managers – but from a more detached perspective, as GFA is not managing any investments. The commercial eye of managing director Simon Hopkins is sharp and his views are unlike those of other interviewees.

European Value & Technical Fund

A small hedge fund coming out of a recovery phase co-managed by German-based Value Management & Research AG and UK-based EFM Technical Research Ltd
This case study looks at a unique co-management arrangement. As the two managers have different functions that have to work together, their specific roles have to be well defined. Thus the responsibilities and tasks in running an equity-based hedge fund, normally seamlessly bundled within a hedge fund management operation, are laid out. That hedge funds have to learn the lessons of past mistakes comes through clearly.

Navigator Compass Fund Limited

A start-up hedge fund
Navigator Funds Advisors is an investment advisor that has set up in the last year. This case study reflects the experience of going through the process of satisfying regulators, finding appropriate technology, and being engaged in project management within your own business. Practical lessons can be drawn from the experience of Navigator.




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