By Neil Wilson
Ever since hedge funds took off in Europe in the late 1990s, new funds have been a driving force, arguably the lifeblood of the industry. And for many years, the numbers of new funds just kept on rising. That was until 2007, when the icy grip of the credit crunch first began to take hold. Then, for the next three years, the numbers of new funds launched in Europe—and the assets they raised—kept dropping sharply.
During 2010, perhaps we finally turned the page on the financial crisis, with the numbers of new funds and assets raised finally on the rise again. According to the latest EuroHedge new funds survey, 157 new European hedge funds launched in 2010, raising collective assets of close to $12 billion. That is a long way below the peak of 2006, when an amazing 420 new funds launched in Europe with collective assets of $37 billion.
But for the first time in four years, the number is finally up on the previous year—in 2009, only 142 new funds got started, managing a collective $11.1 billion. Arguably, the rebound is stronger if one also takes into account new launches in a UCITS III format, compatible with rules for onshore funds in the European Union. An additional 115 new UCITS hedge funds launched in 2010—up from 65 the previous year—and with collective assets also up from $5.7 billion to more than $9 billion. However, as in the previous year, a significant proportion of these UCITS launches (at least 40) were so-called clones of existing offshore hedge funds, not really pure start-ups, and these clones also raised more than half of that $9 billion.
So can we now predict brighter times ahead? It is early in what is still a fragile recovery, but I think we can be cautiously optimistic the industry will be both stronger and more dynamic in future.
Back in the boom times of 2005 and 2006, it was arguably too easy to get started, which led to various people who should never have entered the industry launching new funds, in some cases starting up with $1 billion or more. Many of those funds failed to negotiate the financial crisis and have since disappeared.
In the period that followed, however, the pendulum may have swung too far the other way. With an ever-larger proportion of assets coming direct from institutional end investors like pension funds, for a prolonged period the vast majority of inflows were going only to big established names. It became incredibly difficult to attract money to an untried start-up, unless the fund took a seeding deal or joined an established platform. All of this meant less competition for the established players, less choice for investors and an ever more institutional industry—increasingly like the buttoned-up, suit-and-tie world from which the previous generation of hedge fund managers had tried to break free.
There are signs that this phase is finally passing. Some sophisticated investors are trying to get smarter in how they allocate to hedge funds. Rather than investing solely in brand names, some, such as APG in the Netherlands and the Scandinavian institutions backing the Ivaldi Capital platform in London, have decided to hire talent directly and suggest that others invest alongside them. Some are beginning to look more seriously at the next tier down, the medium-size players, and perhaps even to some smaller and newer funds in search of better performance.
The arrival of more genuine start-up talent is another encouraging sign. Changing regulations are now forcing proprietary traders to spin out from the banks and form independent hedge funds. The biggest new fund in Europe last year, the Edoma Capital event-driven strategy, was one of those, managed by former Goldman Sachs trader Pierre-Henri Flamand. Unlike Flamand, most former prop traders are starting small, but many of them have at least some of their own money to invest to get started, and more of them are definitely coming.
A revival of interest in start-ups is also allowing the next generation of portfolio managers at established hedge funds to spin out. Two of the other top 10 new funds in Europe last year—the Theleme Partners global equity fund from former TCI manager Patrick Degorce and the Ridley Park Paragon Fund from former Polar Capital manager Julian Barnett—featured second-generation managers.
It is a slow-burning trend, but that is probably no bad thing. Although it is healthy that interest in new funds is reviving, we do not want to go back to the hype and hysteria that characterized the last boom at its peak.
Launching a new fund should not be too easy. To keep standards high, only the most talented and determined should have a chance to get started. But established players need competition to keep them on their toes, and it is good for hedge fund investors if there is a steady stream of bright new entrepreneurs setting up shop.