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Digital Subscriptions > The Hedge Fund Journal > Issue 124 - July 2017 > Alive & Kicking

Alive & Kicking

The next generation of hedge fund firms

Foreward

Imagine for a moment that the hedge fund industry contains three parallel sectors, divided not by investment strategy or geography but by size of firm. One includes firms managing $1bn or more in assets - there are 703* of these accounting for 88%* of the total hedge fund industry AUM. This group’s star managers feature regularly in the pages of The Wall Street Journal and the Financial Times. Many of its constituents are big institutionalised businesses and its clients include some of the largest institutional investors in the world, such as sovereign wealth funds and public pensions. It contains only a little more than 10% of the industry in terms of numbers of firms but manages close to 90% of the assets.

Much attention focuses on the “billion-dollar club” and firms close to attaining this status. Industry research and performance indexes tend to be skewed to the larger firms. Consultants’ lists of approved hedge funds are dominated by the larger brands. The second sector contains firms managing between $500m and $1bn – there are 319* of these managing 6%* of the total hedge fund industry AUM. Its investor base includes large institutions but family offices and funds of funds are more prevalent. Many of its constituents are building brands and thinking about the steps they need to take to exceed the $1bn threshold.

Then come emerging managers - those that AIMA define as having AUM of up to $500m USD – there are 2052* of these, also managing 6%* of the total hedge fund industry AUM. These managers feature many entrepreneurs and startup businesses. They are often the cradle for the industry’s innovations. Yet much less is known about these smaller firms. Until this research, we did not know, for example, that the average break-even point for sub-$500m firms is about $86m – or that a third of these firms run profitable businesses with less than $50m in assets. This is a significant finding, since other surveys - of the industry as a whole – have suggested that the average breakeven figure is several hundred million dollars. Those data points were heavily influenced by the largest businesses in our industry. It stands to reason that a firm with hundreds of employees and institutional clients in numerous jurisdictions would cost substantially more to run than, say, a five-person outfit managing assets for a small number of clients (as well as its own money).

Our research also sheds new light on the impact of broader trends and themes on this segment of the industry, such as fee pressures, the impact of post-crisis regulations, demands for ever greater methods of alignment of interests, and the optimum mix between in- and out-sourcing.

Smaller hedge fund firms comprise an essential constituency for both our organisations. Sub-$500m firms make up about two-thirds of AIMA’s fund manager members, while GPP is of course a leading prime broker for small and mid-sized hedge funds. We are pleased to be working together to provide insights into this important community, which reflect both the industry’s past, when hedge fund firms were generally smaller and more reliant on investment from family offices and funds of funds, and its future.

*Number of hedge funds and AUM sourced from Preqin, June 2017

Jack Inglis

CEO, AIMA

Sean Capstick

Head of Prime Brokerage, GPP

Executive summary

Sample: We surveyed 135 small and emerging hedge fund managers worldwide with $16bn in combined AUM. Half of the sample are five years old or less. We also spoke to 25 institutional investors. About three-quarters of managers we surveyed fall into the big six categories: equity long/short; global macro; fixed income/credit; CTA/futures; event-driven; and multi-strategy. The rest include niche strategies such as risk premia, big data-driven investing, trade finance, long-only options, and special situations. The findings are categorised into four areas: profitability; fees and expenses; operational challenges; and growth.

Profitability: Surveys of the industry overall have suggested that hedge fund firms need to manage several hundred million dollars in assets in order to break even. But those averages can be skewed by data from larger firms. Among respondents to our survey, the average breakeven point is around $86m, while around a third are able to break even with $50m in assets or less. By strategy, breakeven is highest for global macro hedge fund firms ($132m) and smallest for credit hedge fund firms ($77m). At the same time, the costs of regulation continue to weigh on smaller firms, with almost 90% of respondents allocating up to one-fifth of their total expenditure to compliance, with this number expected to increase when firms adhere to MiFID II.

Fees and expenses: Our findings show that the 2&20 fee structure is less common among smaller managers. In terms of the management fee, only 14% charge 2% or more and about half charge 1.5% or less. For new fund launches, management fees among sub-$500m managers are now only 1.25% on average. In terms of performance fees, about two-thirds of smaller managers are charging less than 20%. About three quarters (77%) expect performance fees to remain unchanged over the next year; 11% expect a decrease and 12% expect an increase Methods of aligning interests between smaller managers and fund investors are growing. Close to 90% of funds have a high watermark – a peak value above which performance fees can be charged. Roughly one-in-three have hurdle rates – a further trigger for performance fees agreed between the manager and investor. And while less common, 8% of smaller managers say their flagship fund provides fee clawbacks to investors under certain conditions.

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Informing the Hedge Fund Community. With access to some of the industry’s biggest names and an astute and talented group of writers and contributors, The Hedge Fund Journal has established itself as a trusted source of information on the hedge fund industry.
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