Regulatory Initiatives, Liquidity Trends, and AI in Relationships

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Industry Insights:

2024 was a year marked by macro and geopolitical uncertainty, but despite this unpredictability, the U.S. equity markets massively outperformed. The S&P 500 and Nasdaq have risen 26% and 28% respectively as of end of November¹. What do we think this current backdrop means and what are a few keys to success in 2025?

1. Lower Quantity but Higher Quality in the New Launch Landscape: While the number of managers launching new funds is lower than in years past, the quality is higher. Hedge fund consultant & technology provider, PivotalPath, has tracked 145 “quality new launches,” defined as managers spinning out of shops with >$1bn in assets. A major backer of these high-quality launches are large Multi-Manager platforms. This is giving much needed “oxygen” to the new launch space, allowing pedigreed groups to get off the ground and cover their startup costs much quicker.
   • Top Performance: Despite the notable decline in both headline launches and liquidations, reversing 2023’s trend when net new launches turned positive, hedge fund industry assets continue to surge, topping the $4 trillion mark, which is likely due to performance-based growth.
     • After experiencing outflows in 2022 and 2023, hedge funds reversed this trend, attracting nearly $23.04 billion of net inflows through Q3 2024, but a majority of the growth in assets, approximately $324.8 billion, has come from hedge fund performance.²
2. Hedge Fund Concentration: The number of hedge funds in the industry is sitting at 8,213, up slightly from the 8,145 that existed in 2023, but below 2015 peaks. As the number of hedge funds remains steady and assets continue to swell higher, the trend of further industry concentration prevails, which is evidenced by the fact that firms with greater than $1bn in AUM account for 85.50% of assets in the industry.²
   • Increased Consolidation: Flows have been bifurcated to the largest ($5bn+) and smallest (<$100mm) managers,² this year pointing, perhaps paradoxically, to this trend of industry consolidation amidst a healthy new launch backdrop.
3. A Spotlight on Performance YTD: On a year-to-date basis, 89% of all hedge funds are reporting positive performance, according to PivotalPath, producing an average return of ~15%. When evaluating fund performance based on AUM, smaller managers in the $100mm to $250mm range have been the best performing cohort year to date, while managers in the $2.5bn to $5bn range are lagging behind by more than 600bps.
   • Alpha Production: Most hedge funds are posting positive returns this year, however, the major hedge fund indices, as tracked by HFR, are lagging behind equity market indices. Through November, the S&P 500 is up about 26%, while the MSCI World has surged about 20%.¹ Contrarily, the HFRI FWC is only up about 10%, and the HFRI Equity Hedge is up approximately 13%.⁴ Despite this, hedge funds are still conserving capital and producing alpha – PivotalPath’s composite hedge fund index demonstrates that through November hedge funds are producing an average 5.8% of alpha over the S&P.
   • Sector Focus: When focusing specifically on healthcare performance, the HFRI Healthcare index is performing above both the XBI and IBB. Growth in both healthcare and technology sector assets have been on a steady incline over the past three years. The growth seen from the healthcare and TMT groups is slightly ahead of that in all equity hedge assets. Interestingly, there are still net outflows which is a contrast from net inflows of the overall hedge fund industry.
4. Fundraising as a Top Challenge in 2024….But Optimism for 2025: Capital raising for hedge fund managers proved challenging in 2024, especially as equity markets surged, interest rates remained high, and economic uncertainty prevailed.
   • Creating Liquidity: Moreover, many institutional allocators still reported being hamstrung by their privates allocations, looking to their hedge fund books as a form of liquidity. In Dynamo Software’s 2024 Hedge Fund Report, hedge fund managers ranked fundraising as their top business challenge, followed by delivering alpha, managing key client relationships, and recruiting talented employees.
   • “Hit the Ground Running”: The majority of hedge funds are determined to increase marketing efforts in 2025, with more than 55% of the groups surveyed in the study anticipating ramping up their capital raising efforts in the New Year.
5. The War for Talent Wages On: As many job seekers are now placing an increased emphasis on firm culture, they may also have expectations of career development opportunities across levels, creating alignment of autonomy, flexibility, and purpose.
   • Trends in Hiring: Unsurprisingly, multi-manager & multi-strategy funds, as well as equity long short managers, have been some of the most active groups hiring new talent, according to data compiled by With Intelligence. Multi-Manager platforms specifically were responsible for nearly 40% of hiring in the industry in Q2 2024. Across all firms, 63% of new hires were on the investment side, while the other 37% were on the noninvestment side, across various legal, operations, and technology focused roles.
   • Role Type: Overall, industry headcount in non-investment roles has increased from 40% to 54% since 2015,⁵ pointing to the increased focus on non-investment functions such as technology and infrastructure, treasury, and portfolio financing.

Regulatory Corner:

SEC’s Regulatory Enforcement Priorities – What’s in focus for 2025?: Coming off a very active year on the regulatory front in 2024, the SEC has released their enforcement priorities for 2025. Some exams have led to full sweeps of all aspects of a firm’s procedures. As a result, compliance teams are focused on making sure their policies and procedures are reflective of the firm’s practices and that their team is well versed on what should be included. Although many of these rules have been discussed at length, below are some current industry insights and areas of focus for our clients:

• Regulation SHO: This rule has a compliance date of January 2^nd, 2025 with the first report due in mid-February (2 weeks post month-end). Managers should begin to track which securities meet the threshold.
• Regulation S-P: The SEC adopted amendments to Regulation SP in May of 2024, and firms with over $1bn AUM have until November 2025 to comply with the ruling.
• AI Enforcement: The term of “AI Washing” has been gaining popularity, especially as regulators want to ensure that managers are not overselling their use of the technology. Because part of the SEC’s focus is on emerging financial technologies, they are expected to release a Predictive Data Analytics rule in 2025, which should encompass managers’ use of AI.
• Marketing Rule: The first sweep of sanctions when the New Marketing Rule was released in 2022 were mostly focused on hypothetical performance and returns. However, now the most common deficiencies  are related to testimonials or endorsements from 3rd party ratings, as well as  fees and expense calculations.
• Cyber Security: The SEC is aiming to evaluate if a fund has a comprehensive business continuity plan in place and that this plan has been tested. Any plans should outline appropriate vendor due diligence processes, as well procedures to ensure investor information is protected. Third party controls and governance practices will also be reviewed

Spotlight on Content and Events:

Terms Analysis: The Jefferies Capital Intelligence team has compiled the most recent trends and fee studies with focuses on Long Only, Healthcare, Emerging Managers, and TMT hedge fund managers. As discussed in the most recent edition of the newsletter, throughout 2024, the team has observed firms being more creative with their terms and fees, oftentimes even creating unique share classes to cater individual investors’ needs. Some key findings from each vertical include:

• Long Only: Since 2022, equity long only mandates have accounted for about 33% of all equity mandates, up from the 30% they accounted for in the 2021-2023 timeframe.
• Healthcare: Historically, healthcare funds have charged higher fees than traditional long short fund; however, after reviewing the fund terms of healthcare funds that launched between 2022-2024, the team found that healthcare terms have become more aligned with traditional long short funds.
• Emerging Managers: Since 2022, the team has consistently observed over 80% of emerging managers choosing to outsource their trading functions, and while less common than choosing to outsource trading, the team has seen more than 30% of emerging managers choosing to outsource their CFO/CCO/COO function.
• TMT: In terms of redemptions, most directional managers required 60 days’ notice, while the most popular notice for low net funds was 45 days. This difference in liquidity may partially be attributed to the variations in directional and low net funds’ holding periods for long positions.

Please reach out to your Jefferies contact for more information on any of the topics above.

Interesting Service Provider Reads: Highlighting Topical Content from Industry Leaders

ACA/NSCP – 2024 AI Benchmarking Survey Results

Akin Gump – Nasdaq Diversity Rule Deemed Unenforceable By 5th Circuit

Dynamo – Dynamo Software’s 2024 Hedge Fund Report

SRZ –REMINDER: SEC Short Position (Form SHO) Filing Deadline Fast Approaching

Jefferies Prime Services Contacts:

¹FactSet, performance data is through November 2024.

²HFR Q3 2024 Hedge Fund Report

³SOFR refers to the Secured Overnight Financing Rate, which is a broad measure of the cost of borrowing cash overnight collateralized by Treasury Securities.

⁴HFRI, performance data is through November 2024.

⁵Arcadian

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