Interest in emerging managers waning, new data shows
Appetite for spin-off hedge funds is waning, according to data from Preqin.
Less $$$ flowing into start-ups and emerging managers
Just 38% of investors said they would invest in a spin-off in 2012, down from 45% in 2010 and 61% in 2009. The Volcker Rule, which forces banks to shed prop trading desks, has led to a surge in new talent entering the hedge fund market. There have been several high-profile spin-outs in recent years – Portman Square Capital (Citi), Frontpoint Partners (Morgan Stanley) and the Hong Kong-based Azentus Capital (Goldman Sachs). However, it is widely accepted that most spin-offs are going to struggle.
It is not just spin-offs that are feeling the pinch. Forty-two percent of investors said they would invest in an emerging manager in 2012 compared with 48% in 2011 and 54% in 2010. A growing number of investors will also shun start-ups. Forty-one percent of investors said they would not look at a start-up compared with 38% in 2011. Seeding continues to decline as investors seek to keep risk off their books. Just 19% of investors will seed a fund, a slight decline from 21% in 2011.
According to a survey by Citi Prime Services, just $5.6 billion went into 352 launch funds in 2011. The total capital invested in start-up funds since 2009 stands at a mere $12.4 billion, or just 0.6% of total hedge fund AuM today indicating how difficult it is to raise capital.
“2011 and 2012 have proved to be challenging years for hedge fund investors and there has been a noticeable shift of investors moving towards investing with more experienced hedge fund managers in the wake of market uncertainty. This has led to a difficult environment for emerging managers attempting to raise capital, with investors often unwilling to take too many risks in these challenging economic times,” read the report.
Emerging managers’ woes are also compounded by investors demanding a longer track record. Sixty six percent of investors will not allocate to a fund with a track record of less than three years, a substantial increase from 46% in 2009. A further 22% of investors require a track record of at least four years. “Managers with a track record stretching back at least three years have shown themselves to be able to cope in challenging economic circumstances making them attractive to cautious investors,” read the report.
The declining interest in start-up and emerging managers is also partly attributable to the growing role of investment consultants. These organisations, which often advise pension funds on alternatives, are loathe to allocate to smaller, niche managers instead preferring brand name shops. Consultants’ dominance cannot be questioned. A Goldman Sachs Prime Brokerage Survey in 2012 revealed 48% of institutional investors used consultants while 49% utilised consultants for operational due diligence.
Funds of funds (70%) remain the biggest enthusiasts for emerging managers, having had to justify their value proposition to investors since 2008. Endowments, which have also been supporters of emerging managers, seem to be reducing their exposures. Fifty percent of endowments said they would invest in an emerging manager, down from 65% in 2010. Family offices have expressed increased appetite for emerging managers with 47% acknowledging they would consider such an opportunity, compared with 44% in 2011. However, this is far below the 54% who said they would invest in emerging managers in 2010.
Pension funds, constrained by binding concentration limits and risk criteria, are less enthusiastic. Twenty-eight percent of private sector pension funds and 21% of public sector pension funds said they would allocate to an emerging manager. “Over the past few years, pension funds have tended to target investments with experienced managers in order to obtain the perceived security offered by well-known funds,” read the report.
Nevertheless, smaller managers have shown to consistently outperform their larger peers. A Neuberger Berman strategy outlook report revealed the average emerging manager returned 9.49% in 2011 against the 7.46% for the average established manager. “The emerging manager hedge fund space is continuing to evolve and these managers are capable of producing strong returns and additional diversification benefits. Investors are becoming increasingly disappointed with hedge fund returns and may be tempted to look towards smaller managers that can offer higher alpha, lower fees and greater transparency,” read the report.