Alive & Kicking

The next generation of hedge fund firms

Originally published in the July 2017 issue

Imagine for a moment that the hedge fund industry contains three parallel sectors, divided not by investment strategy or geography but by size of firm. One includes firms managing $1bn or more in assets – there are 703* of these accounting for 88%* of the total hedge fund industry AUM. This group’s star managers feature regularly in the pages of The Wall Street Journal and the Financial Times. Many of its constituents are big institutionalised businesses and its clients include some of the largest institutional investors in the world, such as sovereign wealth funds and public pensions. It contains only a little more than 10%of the industry in terms of numbers of firms but manages close to 90% of the assets.

Much attention focuses on the “billion-dollar club” and firms close to attaining this status. Industry research and performance indexes tend to be skewed to the larger firms. Consultants’ lists of approved hedge funds are dominated by the larger brands. The second sector contains firms managing between $500m and $1bn – there are 319* of these managing 6%* of the total hedge fund industry AUM. Its investor base includes large institutions but family offices and funds of funds are more prevalent. Many of its constituents are building brands and thinking about the steps they need to take to exceed the $1bn threshold.

Then come emerging managers – those that AIMA define as having AUM of up to $500m USD – there are 2052* of these, also managing 6%* of the total hedge fund industry AUM. These managers feature many entrepreneurs and start-up businesses. They are often the cradle for the industry’s innovations. Yet much less is known about these smaller firms. Until this research, we did not know, for example, that the average break-even point for sub-$500m firms is about $86m – or that a third of these firms run profitable businesses with less than $50m in assets. This is a significant finding, since other surveys – of the industry as a whole – have suggested that the average breakeven figure is several hundred million dollars. Those data points were heavily influenced by the largest businesses in our industry. It stands to reason that a firm with hundreds of employees and institutional clients in numerous jurisdictions would cost substantially more to run than, say, a five-person outfit managing assets for a small number of clients (as well as its own money).

Our research also sheds new light on the impact of broader trends and themes on this segment of the industry, such as fee pressures, the impact of post-crisis regulations, demands for ever greater methods of alignment of interests, and the optimum mix between in- and out-sourcing.

Smaller hedge fund firms comprise an essential constituency for both our organisations. Sub-$500m firms make up about two-thirds of AIMA’s fund manager members, while GPP is of course a leading prime broker for small and mid-sized hedge funds. We are pleased to be working together to provide insights into this important community, which reflect both the industry’s past, when hedge fund firms were generally smaller and more reliant on investment from family offices and funds of funds, and its future.

*Number of hedge funds and AUM sourced from Preqin, June 2017

Jack Inglis

Sean Capstick
Head of Prime Brokerage, GPP

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