Dr. Rama Rao

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"A provocative study that makes one think about the future structure of the hedge fund industry. A timely study released as major deals are coming to light."

Lois Peltz, Managing Editor-MAR/HEDGE

"Exceptionally solid work, clear reasoning and well documented. Conclusions are both logical and insightful."

Hunt Taylor, Executive Director- Tass Management, Inc.

"This report addresses the rising tide of wealth in the U.S. and the bright future for alternative asset managers going into the next century. It also suggests we may begin to see a consolidation among alternative asset managers similar to what has been occurring in the traditional asset management industry over the last decade."

H. Bruce McEver, President-Berkshire Capital Corp.

"I read the report with admiration and recognition. It presents a very credible vision of the future of the hedge fund industry."

Arthur J. Samberg, Chairman & CEO- Dawson-Samberg Capital Management, Inc.

"This is a wonderful report on the hedge fund industry and the evolution concept is well articulated. We believe one day it will be considered imprudent not to hedge. Interestingly, Harvard, Yale, Stanford and Duke Universities already subscribe to that philosophy."

E. Lee Hennessee-Hennessee Hedge Fund Advisory Group

"This report puts a unique perspective on the hedge fund industry, and shares insight that was not previously available anywhere."

Peter W. Testaverde Jr., Partner Financial Services Group- Goldstein Golub Kessler & Co.

Foundation & Endowment
Money Management

A PUBLICATION OF INSTITUTIONAL INVESTOR, INC.

AUGUST 1999
VOL. II, NO. 8

GOING THE WAY OF THE MUTUAL FUND
HEDGE FUNDS ON INSTITUTIONAL TRACK.

Lucrative. Fragmented. Individualized. All describe the mutual fund industry in its infancy circa 1980 and, many would agree, the hedge fund industry today. In a recent discussion on the evolution of the hedge fund industry, Rama Rao, CEO of RR Capital Management, outlined his case that the hedge fund industry is heading on the same track as mutual funds-an institutionalized, global industry that, like mutual funds two decades ago, stands poised to explode. Rao spoke last month at the Managed Funds Association's "Forum99: The Forum for Managed Futures & Hedge Funds," in New York (see related story, page 4).

In a study released earlier this year, Rao and Jerry Syilagyi, director of financial services at KPMG Consulting, estimate hedge fund assets will grow from about $200 billion to at least $1.7 trillion over the next decade. They estimate that foundations and endowments, which make up only a small percentage of total hedge fund assets, will allocate an estimated $16 billion to hedge funds by 2009, up from an estimated $3.2 billion in 1997.

"The hypergrowth rate in mutual fund assets lasted more than 20 years," Rao said, adding that the upward inflection of growth for hedge fund assets is only entering its 10th year. The study pegs total hedge fund assets at $1.7 trillion a decade from now, with $200 billion in new hedge fund assets coming from institutions, mostly pension funds, because those assets comprise the largest piece of the overall institutional pie. "Extrapolations take into consideration a 10% growth rate in institutional assets and the assumption of only a negligible increase in allocation," Rao said afterwards. "But all indications are that foundations and endowments will increase their allocation percentages because they don't have any ERISA restrictions. Pension fund and insurance allocations will remain lower because of restrictions."

Investors will demand more transparency and performance attribution. Eventually, as was the case with the mutual fund industry, consolidation and increased competition for assets will drive fees down.

"As the hedge fund industry becomes more institutionalized, the pressure will be on managers to offer the most competitive fees," he said.

Looking at the mutual fund industry, which has some $6 trillion in assets, a majority of the assets-80%-are controlled by families of mutual funds. "In 1980, the percentage of assets controlled by mutual fund families was only 20%," he said.

Rao is quick to point out that funds-of-funds differ from a family of funds in that with the former, the fund manager picks the funds; a family of funds is driven by the investor and thus families are set up off a centralized platform to offer a full palate of styles and strategies.

"There is no Fidelity of the hedge fund world right now," Rao asserted. "The closest thing is Paloma Partners, Soros, these have multiple funds, but these fund managers dictate the styles, which are similar. There is no family of hedge funds incorporating a full array of strategies."

Just as a mutual funds' success rises and falls with the Morningstar rating attached to it, Rao sees an emergence of rating systems from hedge fund performance data providers such as TASS, Managed Account Reports, HFR and Barron.

Recently, Tremont Advisers, which owns TASS, joined forces with Credit Suisse First Boston to create a hedge fund index.

As Rao's session was coming to a close, an audience member, Joe Pescatore, who heads up the absolute return strategies group at State Street Global Advisors, took issue with the thrust of the hypothesis.

Pescatore argued that the barriers for entry were low enough and distribution was on a wide enough scale that when the mutual fund industry hit its point of inflection, that is when the growth curve began its upward slope, the industry took off and never looked back.

Plus, he said, it's going to be difficult to institutionalize the entrepreneurial hedge fund culture. If big money managers, banks and insurance companies start making inroads, it's liable to cause the top talent to walk: "What's left will be the second stringers and investors will always want the A-team." Rao countered that a proliferation of information and increased comfort levels led to the takeoff of the mutual fund industry, and the same will hold true for hedge funds. "The number of potential investors in hedge funds is smaller than with mutual funds, but the assets this group controls are much higher."
-Rich Blake