Excess Supply of Emerging Managers to Come?

January 26th, 2010
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Contributed by: Simon Kerr
One of the consequences of the growth of institutionalisation of the hedge fund business is that it has become a lot harder for small and start-up hedge fund managers to get commercial traction. In the late Nineties it seemed that a manager only had to turn up with a credible background and they could launch with $30 to 50m. In the early Noughties it was still fairly easy to set up and it was quite common for a large wealth management company or fund of hedge funds to put a manager they believed in into business. From 2003 onwards the bar was raised for start-ups – managers had to come to potential backers with much more of a complete package, including a preference for two portfolio managers and an analyst or two. "We expect start-ups to have a headcount of five or six," was a typical quotation at the time. It was not impossible to get going on either a bigger or smaller scale, but if it was smaller it was odds-against.

In the period 2005-2007 asset flows into the hedge fund industry became the dominant driver. The consequences included a break-away pack of winners amongst allocators of capital to hedge funds. The flows of new capital were dominated by institutional assets such that institutional imperatives dominated the processes and mind-sets of funds of funds businesses. Ticket sizes became bigger generally. And this was a problem to new and smaller funds – as investors in hedge funds commonly have prudence rules that limit the percentage of assets of a fund they can represent. In this era the second generation manager was the most successful route to hedge fund launches. This was a very safe route for the middle men of the business – as many more of the boxes could be ticked at launch, particularly if the second generation manager stayed under the same roof. The same can be said where additional strategies were launched by the management company for a successful large hedge fund.

Times since the middle of 2008 have been tougher for newly launched funds. There were far fewer of them, but redemptions across the industry made things very difficult. The outflows of capital across all funds left capacity at great and very good managers. Logically the first flows into the industry went to the best managers with available capacity, which was all of them.

New Supply

Late into 2009 the word was that the reining back of capital at investment banks, but across the sell-side generally, was going to compel an outflow of talent into the hedge fund world. Investment management consultancy Laven Partners have said that they are seeing a trend for traders from banks to launch new businesses, partly reflecting concerns about remuneration levels within banks. They say that many traders working as the number 2 or 3 portfolio manager in a fund feel that now is the time to strike out on their own. In particular this is true in funds that are well below their high water mark. Other service providers confirm the trend - prime brokerage departments were said to be running longer lists of newly formed funds coming to market. For example Morgan Stanley reported a 10% increase in prime brokerage clients in the 4th quarter. So 2010 is expected to build on the recovery in launches of the second half of 2009.

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