SALT 2012: Smaller hedge funds feeling the pinch

09 May, 2012

Smaller hedge fund managers are feeling the pinch as investors increasingly allocate to the bigger players while regulators continue to impose ever more onerous rules on the industry, according to experts.

Speaking at SALT 2012 in Las Vegas, Ken Heinz, president of Hedge Fund Research, the Chicago-based data provider, said inflows were disproportionately moving towards the largest managers at the expense of smaller funds.

“Most of the capital is flowing into managers with more than $5 billion in Assets under Management (AuM). The figures we are seeing display a lack of risk conviction among investors in the current market environment,” said Heinz.

According to PerTrac, 60% of the total $1.8 trillion hedge fund industry AuM is controlled by just 322 managers, or just 3.9% of hedge funds.  Many investors are loathe to invest into smaller funds due to risk issues and binding concentration limits despite these organisations consistently outperforming their larger counterparts.

A recent survey by Goldman Sachs Prime Brokerage highlighted the disparities between investors over minimum AuM requirements. The survey found that private banks, for example, have a minimum AuM requirement of $100 million while most sovereign wealth funds will not consider a sub-$500 million manager.

“As the industry gets ever more institutional, it is almost inevitable they will go for larger hedge funds,” said Ray Nolte, managing partner and chief investment officer at Skybridge, the $6 billion fund of hedge funds and SALT organiser.

Ingrid Pierce, partner at Walkers law firm in Cayman Islands, agreed. “$5 billion appears to be the magic number to attract significant institutional capital,” she said.

Funds of funds, having to justify their value add post-crisis, have however been increasingly focusing on emerging managers or niche strategies. “A lot of funds of funds consider mid-sized managers. We do not have rigid rules pertaining to minimum AuM but we focus most of our resources on managers who have assets between $250 million and $750 million. Oftentimes, if we put cash into big hedge funds, it can lead to complexities,” commented Paul Zummo, co-head of J.P Morgan Alternative Asset Management and chief investment officer.

Managers of all sizes are also facing fee pressures from investors reluctant to pay the textbook 2% management and 20% performance fee. “Investors ultimately speak with their chequebook. According to our data, management fees stand roughly at 1.6% while performance fees are at 18%,” said Heinz.

Nolte acknowledged high-pedigree funds too were starting to offer discounts. “A few years ago, it tended to be the funds which did not have mass appeal which offered fee discounts. Nowadays, we are seeing more firms reducing their fees, and these are high-calibre firms,” he said.

Perhaps one of the biggest barriers to entry for smaller managers is regulation. Managers are facing a deluge of rules such as Dodd Frank, AIFMD, FATCA and mandatory clearing of OTC derivatives. “Regulation is hurting the industry, but it is particularly hurting the smaller managers. A lot of these managers are struggling to cope with the rules,” said Pierce.