Lower Hedge Fund Return Expectations: Happy Investors, Happy Hedge Fund Insurers

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The lower return expectations and feeling among investors that, on balance, hedge funds had performed as expected or better in 2012 should be positive news for those in the insurance industry covering the professional liability risks of hedge funds.

One of the profile areas insurers of hedge funds prefer to see when considering the risk exposures of hedge funds are positive returns, returns exceeding the benchmark or returns available compared to other asset classes. The theoretical link is obvious—satisfied investors generally tend to have less to complain about to their hedge fund managers or to seek compensation for losses.

The cited lowering of return expectations by institutional investors means the hedge fund industry can get on and deliver superior risk-adjusted returns without feeling the need to ‘shoot the lights out’ to keep investors happy. From a risk management perspective such pressure to deliver higher returns, especially in the current market backdrop, may lead some to take increased risk. Insurers of hedge funds would prefer that didn’t happen. The root of a number of insurance claims can be attributable to trades which may have been made attempting to deliver on higher investor expectations.

Hedge fund insurers have long preferred the risk profile of the predominantly institutional investor. Investors chasing higher returns, such as private banks, may in theory lead managers to take greater risks to retain those investors if returns are not at the higher level expected. If the institutional investor expectations going forward are for more conservative returns, perhaps over a sustained period, this has to be positive news for those insuring the risks of hedge funds.

‘A healthy marketplace’

Insurers’ attitudes to insuring hedge funds has changed dramatically over the last decade and appetite has increased. There is now a healthy market place for insuring the professional and management liabilities of hedge funds. Those who can differentiate their operational risk exposures will be able to extract the widest policy coverage at the most competitive price. This includes demonstrating a lower potential for investor complaints or claims. The profile and attitude of the investor base is just one of those areas of differentiation but indications that certain investors are seeking longer term average returns is overall positive news. After all, this is likely to be the same expectation of the shareholders of hedge fund insurers.

About Paul Richards

Paul is Executive Director and Co-FI Practice Leader in Willis Towers Watson's FINEX Global division. Based in Lon…
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