Monday, November 30, 2015

Hedge fund industry - all about scale?

As of Oct. 31, an estimated 90% of the nearly $3 trillion of global hedge fund assets was in the hands of firms that manage more than $1 billion, according to HFR, a Chicago firm that tracks the industry. In contrast, firms overseeing less than $100 million accounted for under 5% of total assets. And roughly two-thirds of hedge fund assets are managed by the top 6% of all hedge-fund firms.

The hedge fund industry ecosystem is now about scale and not just skill. There may still be skill with hedge funds, but as firms get larger, there is more focus on maintaining the stability in AUM and management fee. There is also more focus on diversifying styles and products under the same firm name. This diversification dilutes manager focus.

Hedge fund behavior changes with scale and is one of the reasons for the better performance for smaller managers. Larger managers are more risk averse.  Smaller firms  are willing to take on risks in order to gain recognition and generate incentive fees. They do not have the same costs with being wrong and losing assets already acquired. In a relative hedge fund world, small managers have to take more risks to outperform their bigger competitors otherwise there is no reason for an investor to take small firm operating risk. 

With the above stats, it is clear why prime brokers and FCM are no longer interested in servicing the small manager. the do not have the assets and scale to make servicing them profitable. The cost of regulation may hit small firm given their lack of scale. resources will not be available to smaller firms. Hence, the small firms have to create a skill hedge to get noticed. 

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