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 Large institutions managing money for wealthy individuals have
always tended to look towards well-established money managers but
this trend has become more pronounced following the financial
crisis.
According to data from industry tracker Preqin some 90 percent of
assets are now held by just 505 funds worth at least $1 billion.
This means a record concentration of assets - much of the industry's
nearly $3 trillion - in older and larger funds, hedge fund database
eVestment said.[ID:nL6N0O136A]
As a result young funds are finding it even more difficult to
attract clients in an environment that is tougher than it has ever
been.
The combination of more demanding clients, higher regulatory costs
and the fallout from the financial crisis saw the number of young
hedge funds with a 10 month record of managing money fall from a
peak of 1,610 in 2007 to 492 in 2013, eVestment data showed.
"It is more difficult for younger funds, if they're not launching
with enough assets, to ... get started at all," said Peter Laurelli,
vice president of research at eVestment.
However, the study by eVestment, using data from its database of
7,700 funds, showed funds under two years old, outperformed those
aged two to five years or older.
Young funds had the highest cumulative return from January 2003 to
December 2013, at 210.56 percent. The mid-age index came in second
at 128.93 percent and the oldest, or 'tenured' funds posted returns
of 123.69 percent, it said.
"A lot of the big hedge funds that have made a name for themselves
have grown so large that it's arguably taken an edge off their
performance," said Bill Muysken, chief investment officer at
consultants Mercer, which advises and places money for pension
funds.
"There are a lot of those large funds that we love, but we'd love
them more if they were running half the money, and love them even
more if they were running half as much again."
SAFE OPTION?
Many investors who were burned by the volatile markets of the
financial crisis have turned to big hedge funds for the more stable
returns and safety of size - scale, solid infrastructure and
operational security.
But according to eVestment, young funds provide better returns
precisely because many are not hampered by size, are better able to
time a launch to match market conditions and are generally more
willing to take on risk to establish a good track record.
For Mercer's Muysken, the most important issue is whether a business
can grow enough to cover its costs, a figure he put at anywhere
between $100 million and $200 million.
"Otherwise it's going to be a disappointing experience all round if
we invest and they decide at some point they haven't got a viable
business."
There's also a practical issue to consider.
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Even when big investors wanted to place a portion of their assets
into smaller funds, many were unable to do so because the scale of
their business demanded a minimum mandate size, usually around $10
million.
Credit Suisse's 2014 hedge fund investor survey showed only a third
of respondents would invest in a fund under $50 million, while just
over half could invest in one between $50 million and $100 million
and three-quarters could do so in one over $100 million.
NEW RULES, NEW PLAYERS?
Small hedge funds seeking to attract institutional investors have
also suffered a loss of support from some of their traditional
backers, investment banks, following the introduction of new
regulations.
Tighter rules demanding that banks have higher levels of capital to
protect against risk have resulted in their prime brokerage units,
which provide services like financing and stock lending to hedge
funds, becoming more cautious.
"We have to be a lot more certain of ourselves that these guys are
the ones that are going to grow, and it may take 3, 4 or 5 years for
them to grow into a customer that's meaningful," said a hedge fund
consultant at a leading investment bank.
"If you're less than $100 million, a pension fund may love your
return profile but say 'I can only write you $10 million and you're
at $80 million, come back when you've raised another $20 million,"
he said.
But while regulation may be hampering the growth of some small
funds, other post-crisis regulation like the Volcker Rule - which
stops U.S. banks from trading on their own account - may yet boost
young funds.
There has been a significant increase in the number of investment
banks spinning off hedge funds made up of their trading teams, says
Jonathan de Lance-Holmes, partner at legal firm Linklaters, "and
there's a lot more to come".
(Additional reporting by Nishant Kumar in Hong Kong and Svea
Herbst-Bayliss in Boston; Editing by Sophie Walker)
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