No longer pariahs, funds of hedge funds making a comeback with investors

Like Sarah Ferguson, the disgraced Duchess of York whose latest faux pas was trying to sell access to her ex-husband Prince Andrew, FoHFs had become the pariah of the broader hedge fund royal family.

Like Fergie, they were collectively banished to the outskirts, made the odd ones out and certainly not invited to the post-Great Recession (read: Will and Kate’s wedding) festivities. This happened partly because of their own poor performance and partly because of their association with hucksters and fraudsters (Madoff anyone?).

But there’s good news for the outcasts – at least the FoHF. While still suffering from one of the most difficult fundraising and asset-retaining periods ever, shoots of recovery are beginning to emerge as industry assets under management start to grow again, according to Preqin’s latest FoHF report.

Indeed, despite Madoff, poor relative performance and investor withdrawals, and, despite significant shrinkage, stability is returning to the industry.

The report (click here to download), which analyzed the profiles of 535 FoHF managers, looks more closely at the size of the industry as it stands today and the changes that have occurred since the financial crisis.

Among some of the more interesting findings is a bifurcation in terms of size: the smallest fund monitored by Preqin manages less than $1 million in assets, while the largest runs upwards of $35 billion in assets under management. (See chart below.)

Of more interest is the trend over the past 12 months of smaller FoHFs getting more share of the money pie. According to Preqin, 28% of FoHFs had AUM of less than $250 million in 2010; as of the second quarter of this year, that number had increased to 35%. The most notable shift was those in the middle: managers with assets of between $2 billion and $4.9 billion, Preqin found.

Overall, the size of the average FoHF fell to $2.18 billion from $2.75 billion during the same period in 2010.

But it looks like the tide has turned. Thanks to improving performance, new investors and significant improvement in investor demand following widespread changes in the industry – increased transparency and due diligence measures, among the most notable – aggregate assets under management rose from $902 billion to $910 billion between 2010 and 2011.

“With only a quarter of the year gone, the potential for further growth in the FoHF sector this year looks strong,” said Preqin.

The chart below demonstrates the post-2008 the dramatic change in fortunes for the sector. From 2007 and into 2008, fundraising was still very positive as over 55% of firms reporting an increase in AUM over the period. This trend then took a nosedive from 2008 into 2009 with a significant difference between the proportion of firms reporting a decline in AUM (43%) and those reporting an increase (17%).

The gap narrowed from 2009 to 2010, although was firmly still in negative territory and, as a result, the sector continued to shrink. However, the number of firms that have reported an increase in assets from 2010 into 2011 so far outweighs the number of firms that have seen their AUM fall. “If this trend continues over 2011, the AUM for the FoHF industry could rise towards $950 million in AUM by year end, eclipsing the $1 trillion mark over the longer term,” notes Preqin.

And where would the money come from? Institutions who collectively want to be in the hedge fund game but in many cases would still rather farm out the task of selecting and monitoring managers and strategies, the researchers suggest.

Given they have more leeway in terms of negotiating fees and liquidity and more access to seeing underlying managers, strategies and operational standards, the trend back to FoHFs is on the upswing.

It’s hard to imagine Fergie being re-embraced by the royal family, even if she did manage to clean up her reputation a little. Luckily for FoHFs, the hedge fund investing family is a bit more forgiving – for now.

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