With the dramatic growth of the hedge fund industry over the past decade, one might be excused for believing the alpha genie was out of the bottle. After all, if current trends continue, there will be a hedge fund on every corner, right?
However, there is little doubt that the hedge fund industry is also becoming more concentrated than ever (see related posting). To a great extent, this trend is self-reinforcing. The more assets managed by the large funds, the more comfort institutions feel when investing in them.
But a recent report by Watson Wyatt seems to suggest that hedge funds of fund concentration pails in comparison to concentration in private equity funds of funds.
Readers with an interest in the geopolitics of developing nations will be familiar with the Gini Coefficient. First used in 1912, it is generally used as a measure of income equality. A Gini Coefficient of 0.0 denotes perfect income distribution while a Gini Coefficient close to 1.0 represents very high income inequality. Graphically, the Gini Coefficient can be described as the yellow segment divided by the entire white triangle on the chart to the right.
But this simple graphical representation can be used to describe a myriad of distributions. In fact, a new report from Watson Wyatt uses the Gini Coefficient to measure the level of concentration on the alternative investment industry (hedge, real estate, commodities, & private equity).
The report is May’s “Global Alternatives Survey” and it polls 150 firms (about a third hedge funds of funds, a third real estate funds, and a third either private equity funds of funds or commodities). The findings contain a Gini Coefficient for each branch of the industry. While it’s difficult to objectively assess the Gini Coefficients without a benchmark, the report seems to suggest that hedge funds of funds are actually less concentrated than their compatriots private equity, real estate and commodities. In fact, the report describes hedge fund of funds AUM as being “relatively equally distributed”.
Watson Wyatt says the Gini Coefficient for hedge funds of funds is 0.37. Compare this to a Gini Coefficient of 0.59 for private equity funds of funds (below).
We were a little surprised that hedge funds didn’t seem that concentrated after all – at least not compared to private equity funds of funds.
But this apparent inconsistency between the report and other empirical evidence can be explained by the sampling strategy used by Watson Wyatt. The firm polled 30 large hedge funds of funds (the mean AUM of the smallest quartile was $1.5b). So the lower Gini Coefficient for hedge funds only proves that the largest hedge funds tend to have relatively similar asset sizes. It’s likely that these large funds will continue to grow in relation to the vast majority of (smaller) hedge funds.
A lower rate of fund launches and a concurrent dramatic growth of the largest funds will surely increase the Gini Coefficient of the hedge fund industry in the years to come.
Sure, the genie popped out of the bottle some time ago. But then, after diligently registering with the SEC, he realized it was harder than he thought to grant wishes.