By Nick Evans
The formation this month by global hedge fund association AIMA of a dedicated forum for smaller managers is a very welcome and important step. It serves as a timely reminder that the hedge fund industry is not and never has been just about a small number of large managers. It is a business whose diversity, dynamism, spirit of entrepreneurialism and continual capacity for reinvention and renewal are among its greatest strengths and assets.
For all its excellent intentions and largely laudable work, the impression given by the Hedge Fund Standards Board has sometimes appeared to be that only the big guys matter. That has also seemed to be the attitude of the regulators, certainly in the UK. Their overriding focus on a small group of larger managers may perhaps be justifiable in terms of systemic risk management, although such a narrow field of vision can hardly give the financial supervisors a rounded view. But it has also helped to fuel the perception that the hedge fund industry can be boiled down to a hard core of a few multi-billion-dollar firms and that the vast majority of smaller funds, most of them managing only a few hundred million dollars or less, are irrelevant.
This notion is wrong. It is unhelpful to anyone trying to understand why hedge funds are important, why they can provide such value to investors and why they provide such diversity for the financial system. And, above all, it is dangerous for investors as well encouraging a herd-like mentality where they all allocate to the same, supposedly safe, larger funds.
This concentration of assets has been one major consequence of the financial crisis and it is perhaps an unavoidable aspect of the increasing institutionalisation of the industry, at least in its early stages. But it is already having some unfortunate, and rather predictable, results. Time and again it has been shown in hedge funds that size can be the enemy of performance. And it is no surprise to see that some of the larger, and arguably less nimble, funds are those that are struggling most this year in a very unpredictable and fast-changing investment environment where flexibility and agility are increasingly essential.
As AIMA chief executive Andrew Baker says: Even todays giants of the industry started out small. And the process is not one-way, either. The industry is also littered with examples of yesterdays giants that have become small again with RAB just the latest in a long line.
As our first-half new fund survey this month shows, the hedge fund industry has lost none of its capacity for renewal despite the devastating events that it has had to deal with over the past few years. In purely quantitative terms, the numbers of new launches are still down a long way from the pre-crash bubble era. That is only to be expected and it may remain the case for a while yet. This is not, after all, a very promising environment for starting any new business.
But what counts is that the quality is high and rising fast. Arguably there is more high-calibre talent coming through than at any other time over the past 10 years. And the smarter investors and seeders can sense that there is a unique opportunity to get in early with many funds that could well be tomorrows stars.
It is not surprising that the more institutional investors have not reached this point yet and that their overwhelming priority at this still relatively early stage of their involvement with hedge funds is to minimise headline or career risk. But already there are signs that pension funds, and their hugely influential investment consultants, are starting to cast their nets more widely in search of the smaller boutique managers that can add value and diversification to their investment portfolios and objectives. That is very encouraging and gives grounds for hope that the inevitable institutionalisation of the industry need not also mean the eradication of its entrepreneurial spirit.
As AIMA makes clear, the pressures on smaller managers are different from those on the big guys. To be sure, this is a very testing time for boutiques and the challenges are intense. But it is entirely in the interests of the financial industry as a whole and, most importantly, of all those investing in hedge funds that the smaller firms do not get squeezed out.
So we strongly support AIMA for focusing attention on the smaller managers that form the lifeblood and the beating heart of this most dynamic and enterprising of businesses.
Now more than ever, it is crucial that the boutique smaller firms should not just survive but thrive. Without them, the industry would be a far less diverse, competitive and interesting place and the biggest losers would be the investors.