Hedge funds starting to get “voted off the island”

As the hedge fund industry matures, assets are flowing disproportionately to the larger players in what some have called a “shakeout”.  Taking a page from TV’s “Survivor”, investors are apparently starting to vote smaller players off the (Manhattan) island.

Usually, the term “shakeout” refers to the culling of weaker, smaller players in an industry in favour of the larger and more dominant competitors.  So it’s striking that Business Week this week suggests that the “parade of cave-ins” in Hedgistan included funds managed by major financial institutions (e.g. Citi, UBS, and parade-marshal Bear Stearns).

The ones doing the culling?  Pure play asset managers such as Bridgewater and BGI.  In fairness, JP Morgan (which bought and subsequently grew Highbridge) and Goldman (which today announced its hide was saved in Q2 by its asset management business), buck the trend.  But 8 of the top 10 largest hedge fund managers in Alpha magazine’s listing of the largest US hedge funds last month were NOT run by investment banks or other large financial services firms (we’d say that #9 BGI runs pretty independently of Barclays).  So the question remains, what’s up with the bank-run hedge funds?

Despite a rocky road for some bank-owned hedge funds, size continues to be an advantage.  Reports BusinessWeek:

“Despite all that, the big players are still capturing the lion’s share of new inflows from institutional investors. ‘So investors are saying, ‘This is a good wake-up call for me.’ They know that putting capital with big banks may not necessarily be safe,’ says [Brad] Ziff, [head of the hedge funds advisory practice at Oliver Wyman]. ‘But is that where they are still concentrating their assets? From everything we are seeing, the answer is yes.'”

The Wall Street Journal takes a more traditional view of “shakeout” in with a major story in yesterday’s paper.  The Journal piece doesn’t discriminate between bank-owned mega-funds and pure play mega-funds.  Instead it observes, as we have, that asset concentration of assets among the largest players (bank-owned or not) continues to be a (the?) dominant trend in the hedge fund industry:

“By the end of last year, 87% of all the money in the business was handled by funds managing $1 billion or more, and 60% was held by managers sitting on $5 billion or more. The dominance by the largest funds has been accelerating: In the past two months alone, the world’s largest public hedge-fund company, Man Group PLC, increased assets by $4 billion, to $78.5 billion.”

According to figures from Hedge Fund Research cited by the Journal, the hedge industry is following the path of many other highly scalable industries before it – with smaller players either giving up or being taken out by the larger players.

Compounding this, as the chart from the Journal (above) shows, Q1 net new assets flows have decreased markedly over last year.  Reuters blames this “shriveling” of asset inflows on poor returns:

“This marked the fourth consecutive quarterly inflow decline.  Investors have punished managers in the once hot $2 trillion hedge fund industry for poor returns all year.”

And HedgeWeek says the declining, yet positive, net inflow amount ignores the direct effect of Q1’s negative returns on assets under management (a number that is actually many times larger than the decrease in net inflows):

“Net hedge fund industry inflows slumped to USD2.62bn during the first quarter of 2008, according to the latest Lipper Tass study. Combined with a net performance loss of some USD36bn, this resulted in estimated net hedge fund industry assets falling to USD1.75trn at the end of March from an USD1.79trn at the end of December 2007.”

With all this talk of “shakeouts” and “shrivelling”, we’re reminded of another article about the demise of the hedge fund industry that read:

“Apparently, if it is not the end, it is certainly the beginning of the end. From all corners of the globe, there are hordes of scribblers, some esteemed, many not, announcing that hedge funds have passed the point of no return and from here on in things can only go down, lower and ultimately into the depths of despair.”

While this excerpt could have been written last week or last month, it was actually written by an astute industry observer in August 2001.

[Ed: late breaking related story – Hedge funds enjoy best month so far this year in May to continue April rally]

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  1. Speculator
    June 20, 2008 at 12:38 pm

    I think managed money is at an end of a bubble. The big established funds are going to get all the money and some are going to blow up before this bubble deflations. Over a 10 year period most don’t beat the SP 500 anyways.

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