Rafik Patel, of FSP Search, in conversation with James Cullen of the growth in the hedge fund industry.
The hedge fund industry consists of nearly 6,000 funds globally, and manages approximately $ 900 billion in assets. Many hedge funds are relatively young (less than five years) and relatively low (less than $ 25 million under management), which focuses on the fact that hedge funds have recently become very popular with more mainstream investors.
Q2: We understand the hedge fund market is no longer the special province of the u.s. operators, and that other areas, including Asia and Europe have experienced a tremendous growth in terms of asset size and start-up companies over the past five years. How has this happened?
This is mainly an issue of supply and demand. With strong investor demand and no sign up fees to come down, simply, it makes a lot of sense for portfolio managers, traders, marketing, etc, to start a hedge fund the operation. With an average price of 2% flat plus 20% of the profit, these people can do a lot better on their own than working for a large bank or asset manager, even if they are able to raise only $100 million.
Q3: Given the kind of exponential growth we’ve talked about, is it a probability that the yield will be pulled down as the hedge funds are flooded with capital? After all, it is the role of managers and arbitrageurs to normalise and provide liquidity on the market?
It is clear that the golden age of hedge funds are a thing of the past, and each year following, after having shown a worse performance than the previous one. It all depends on the strategy followed, though. Global macro funds will probably last longer, as many of them operate in liquid markets. More specialized funds, such as convertible arbitrage, are already suffering. There are not enough convertibles in the world to support the assets under management by this type of fund.
Q4: Is it fair to say that the European theatre is best suited to the single-manager operating funds?
No. Most European investors use funds of funds, which is multi-manager funds. For investors who do not have the skills needed to select the funds themselves, which do not have the size to allow them to choose their own fund, or who simply do not want to take responsibility for selection of funds (as is often the case with institutional investors), funds of funds are essentially the only alternative.
Q5: compared to a single fund manager, the fund manager’s total trading authority. It has been deduced that the use of a single manager can lead to a lack of diversification and higher risk. From an empirical point of view, these inferences have any validity?
Yes. Individual hedge funds have a high degree of idiosyncratic risk because you are basically building on the ideas of only one or two people. In addition, approximately 15 percent of all hedge funds will close each year, because of the lack of size or lack of performance. Because of this, it is almost a necessity to hold a portfolio of funds instead of one fund.
Q6: With thousands of hedge funds to choose from, each claiming to have an “edge”, where the novice investor start?
The novice investor should not try to make the selection of the fund itself. The whole process of due diligence and portfolio construction which comes next, is just too complex for DIY.
Q7: Pension funds and hedge funds – the twain ever meet?
Yes, because pension funds tend to mimic each other. If the big ones go for hedge funds, the smaller will follow. With interest rates at a historic low, the uncertainty about the future of the stock market, institutional investors, and eagerly looking for something to offset the recent losses (or to be seen doing at least something), hedge funds have been welcomed with open arms by the top pension funds. It is only a matter of time before many smaller funds follow suit. The only thing that can prevent this is lack of performance. Hedge funds need to convince pension funds that they are worth the hassle and the relatively high proportion of the costs. If the performance remains, however, the hedge fund idea will become more and more difficult to sell.
Q8: How investments in hedge funds affected by the current conditions of the market?
A large part of the interest in hedge funds is driven by a lack of alternatives. Many investors do not know where to put their money and are struggling to recover from serious losses in the stock market. So they are very much open to alternatives at the present time. It is exactly at this point that a hedge fund marketing start knocking at your door. What do you expect?