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Although not in the news as much as before, sovereign wealth funds have “retained their collective significance in the world of institutional investors,” according to a new report from Preqin, a data provider.

State-controlled funds now boast US$3.59trn in assets under management, up 11% from the previous year. This is encouraging for hedge fund and private equity managers, as sovereign funds’ general lack of liabilities gives them more leeway to invest in “riskier, less liquid and alternative investments,” Preqin notes. As the risk appetite of other investors wanes, this presents a potentially vital source of funds to an alternative-investment industry that’s feeling the squeeze.

Traders love volatility. Traders at hedge funds should particularly enjoy volatility, given the leeway they have to invest in a wide variety of securities and take both long and short positions. And although not all funds state it explicitly, “market neutral” performance—that is, growth in both good times and bad—is often used to justify hefty fees.

A recent study by ratings agency Moody’s compared monthly changes in a global index of hedge fund performance to the VIX index, a measure of volatility, going back to 1994. Large, sudden spikes in volatility tend to coincide with large losses for funds. “This stands to reason,” Moody’s writes, because a “sudden re-pricing of risk across the board can catch [hedge fund] managers off guard, in the same way as other market participants.” Is this yet more fodder that investors can use to renegotiate fees?

“New rules of engagement are being written.” SEI, an investment services provider, reckons that an “investor empowerment movement” is underway among those that invest in hedge funds.

High net worth investors have accounted for some 80% of hedge fund redemptions in recent quarters, SEI estimates. The institutional investors that remain are using their increased clout to express growing dissatisfaction with funds that have not delivered the absolute returns or downside protection that they charge hefty fees for.

As hedge funds have benefited from the recent rally in asset prices, successive surveys of these investors have seen concerns about performance fade. Meanwhile, worries about transparency, liquidity and investment objectives are on the rise. As a result, investors are putting pressure on funds to “evolve their entrepreneurial operating style to a more institutional and transparent model,” SEI says.

By most accounts, hedge funds are attracting asset inflows after a long stretch of net redemptions. But investors aren’t willing to fork over funds on the same terms as before. As a result, hedge fund managers are preparing for a “less lucrative, more transparent future”.

Two recent surveys—one of investors, the other of fund managers—paint a picture of widespread haggling over fees, redemption terms and the like. Around 30% of both investors and fund managers say that they have already negotiated lower fees. More notably, 22% of investors who have not yet pushed for lower fees expect to soon, twice the share of fund managers who expect to implement changes to fees.

Given the ill will stoked by Madoff, Rajaratnam et al, as well as the old adage that beggars can’t be choosers—despite recent inflows, assets under management remain well below the pre-crisis peak—investors are more likely to have the upper hand.

HF surveys 11-11-09

Sri Lanka’s stock market has been one of the world’s star performers in 2009, with the Colombo All-Share Index up more than 100% for the year. But one man knocked the exchange back today, casting a cloud over the market’s performance in the months ahead.

Sri Lanka 10-19-09

Raj Rajaratnam, the Sri Lanka-born, New York-based hedge fund manager was one of six people arrested on Friday and charged with insider trading. American federal investigators claim that Rajaratnam was at the centre of an insider-trading ring that also included managers from Intel, IBM and McKinsey.

Rajaratnam’s Galleon Group manages US$3.7bn in assets. The founder’s legal troubles have led many to believe that a wave of redemptions is on the way. As a result, traders in Colombo are worried that Galleon’s sizeable stakes in several Sri Lankan firms may be sold to raise funds. Amid generally rising shares elsewhere in Asia, today the Sri Lankan market recorded its largest intraday drop in five years, 3.8%, before recovering to close lower by 1.6%.

UPDATE (Oct 22): Galleon is closing. The Colombo All-Share has slipped an additional 3% over the past three days.

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