The hedge fund industry has taken a well-publicised caning over the past few years but, as the dust starts to settle on the global financial crisis, some interesting and probably long-lasting trends are emerging. Principle among these is a massive increase in concentration of mandates among the larger hedge funds.
According to figures from research firm Hedge Fund Research, the total invested in about 6,000 hedge funds and funds of funds (FoFs), was about $1.65 trillion at the end of last year, against $1.5 trillion 12 months earlier and $1.4 trillion at the end of 2008. The industry peaked at just under $2 trillion in 2007.
The researchers say that most of the recovery has come about from investment returns rather than new money flows and that, of the new money, most of this has been from institutional investors. The high net worth investors who have traditionally made up at least 50 per cent of the client base, have remained on the sidelines since the crisis commenced in August 2007.
The top 30 funds in the world now account for about 30 per cent of all assets in the hedge fund space compared with 20 per cent in 2005. Only one of the five largest last year was also in the top five managers by size five years earlier.
The current top five is: JP Morgan/Highbridge ($53.5 billion), Bridgewater ($43.6 billion), Paulson & Co ($32.0 billion), Brevan Howard ($27.0 billion) and Soros Fund Management ($27.0 billion). The top five in 2005, with 2005 assets, were: Farallon Capital ($12.5 billion), Bridgewater ($11.5 billion), Goldman Sachs ($11.2 billion), GLG Partners ($11.2 billion) and Man Investments ($11.1 billion).
Another trend within the concentration story has been a move towards direct investing rather than through FoFs. It seems that, when investing direct, fiduciary investors are favouring the big names.
Intuitively, none of these recent trends is likely to be good for the end investor, for several reasons.
Firstly, there is no evidence that large hedge fund managers are better than smaller ones. In fact, most of the scant evidence available says the opposite. Hedge funds which employ esoteric or sophisticated strategies are more prone to capacity constraints than long-only managers, even in the global universe.
Hedge funds which are “traders” tend to crowd each other at the very big end, leaving less competition in the middle and smaller end of the market.
Hedge FoFs, while charging higher fees, on average, than directly invested hedge funds, still have the greatest research resources in the marketplace. None of the big consulting firms can match even a medium-sized global hedge FoF for the number of investment analysts and other researchers on the case.
And the fees charged by FoFs have come down considerably in the past three years. Many FoFs will now also build a bespoke portfolio for big pension funds on a flat fee or modest bps-fee basis.
As with the long-only space, in actively managed strategies, the more institutionalised the hedge fund firm the less likely it is to outperform its standard benchmark. If fiduciary investors think they are playing it safe by investing through a very big firm, then they are likely to pay a price for that “safety”.
What is good about the recent trends though, is that hedge funds are getting new investments, at least from the institutional market. They were probably sorely treated in the initial stages of the financial crisis due to liquidity issues and smart investors are now showing that they oftentimes do what they are supposed to do – provide a good hedge against other parts of the investment portfolio.