Pensions & Investments recently published a piece highlighting data from Hedge Fund Research stating that: 186 managers liquidated their funds in the second quarter, compared to 213 in the first quarter and 215 in the fourth quarter of 2018. Hedge fund launches, meanwhile, totaled 153 in the quarter ended June 30, 136 in the fourth quarter of 2018, and 111 in the third quarter.
I have a few takes on why this is to be expected:
- The gold rush is over. Fee compression is rampant, and launches over $100 million are non-existent except for those with a long, storied pedigree. In the absence of the 2% management fee, it is really hard to break even given today’s data, trading, compliance, and administrative costs.
- Hedge funds lost their edge by accepting institutional money. The origins of hedge funds included swashbucklers delivering high double-digit returns. The ability to go long and short frequently increased risk, but the rewards were alluring, with the high net worth and ultras following those returns. Not wanting to be shut out, and with the ability and desire to provide tremendous allocations, institutions and their consultants followed. With that money came a new level of due diligence for both investing and business. All of this could have been industry-enhancing, underscoring the perceived superiority of hedge funds compared to their long-only brethren. However, over time, this took a perverse turn. As institutions compared long-only managers to benchmarks and looked at how much risk for alpha they were willing to take, they, for lack of other clear and comfortable definitions, applied similar performance measurements to hedge funds. “Can you apply that same strategy to a risk budget?” asked institutions. That killed hedge funds entrepreneurs. Yes, as it happened, we all called it the professionalization of hedge funds, no matter how accurate. This, in effect, also resulted in an unintended consequence: larger, more institutionally suited firms saw exponential increases in AUM. Thus, the big got bigger and the small began to fight for scraps. Institutions got their risk budgets and smaller returns.
- Fee compression is self-inflicted. Managing a risk budget delivers near the expected risk/reward. As returns lag broad markets (as they are designed for a risk budget), headlines pressure institutions to stop paying such high fees to get below-market returns. The industry is not great at communicating and now has a low return, high-fee reputation. All of that is changeable with marketing and PR.
- There are a limited number of great managers. This was and always will be true, and I believe a constant. Real talent is born, trained, and has the drive and will to succeed in a really hard business. As in any gold rush, everyone wants to try their hand and have a shot. Only a few make it big, and many, as in other businesses, make it by understanding the game and its rules, mastering just those skill sets. Delivering high double-digit returns is not what institutions are seeking. How about LIBOR +2 with no down years? No more swashbucklers.
One anomaly: managers who have the talent, training, and—thankfully—performance (measured by published and audited numbers, which is the reason I loved my time as a PM—I knew that I was better than 94% of my peers) but never gather assets.
To those funds and managers, I say: turn to E5A. No longer part of the code of a multifactor model, E5A is a systematic, data-driven investor acquisition agency. We are obscure, just like undervalued securities. Most hedge funds go to the same three or four marketing factories and get their logo, fact sheet, and web page—which, in reality, is far from what they really need. They then think that they are done, achieving only the expected result.
Systematic, data-driven investor acquisition is a commitment. It is a path to becoming a recognized brand and a firm for which asset owners of all types want to allocate. Marketing and brand cultivation are keys to success—especially if you don’t have a friend who can start you off with $100 million in AUM, or you want to boost your firm to that next level desired.