Hedge fund assets are exploding and managers seem to have fund their place in the investment world after a couple of years of less than stellar results. Everything seems to have come up positive for hedge funds in 2015, but there is one shadow lurking and it’s been in the background for a long time.
A report from Hedge Fund Research, or HFR, shows that the number of new hedge funds launched in 2014 was lower than that in 2013, a third straight year of decline in the number of launches in the industry. The hedge fund industry is slowly but surely seeing slowing growth of new blood, a situation that could be negative for the sector as a whole.
Hedge fund birth slows
The HFR study recorded the creation of 1040 new hedge funds in 2014, down from the 1060 created in 2013. It’s more and more difficult for new hedge funds to get their hands on the capital needed to put together a functioning investment vehicle as more and more dollars flow to the biggest names in the industry.
Several recent surveys of hedge fund managers and investors alike have found that there is a growing propensity toward investments with larger manager more willing to offer customized funds and enhanced levels of risk control. That tendency is being driven by a trend towards institutional investment in hedge funds across the globe.
Hedge fund launches peaked in the heady days of 2005. that year saw the creation of 2073 new funds. The number dropped to a low of 659 during the financial crisis, in the midst of the darkest days of the 21st century in the financial world.
Kenneth J. Heinz, President of HFR said “In order to be successful, new hedge fund launches must offer compelling, innovative strategies, favorable liquidity and fee terms, top quality structures and services providers, and most importantly, generate strong realized performance. New funds which are able to meet these demanding requirements are likely to emerge as a new generation of industry leaders that drive performance gains and industry capital growth in coming years.”
Dissolution drops in 2014
Despite the falling rate of new funds, there isn’t yet signs of inexorable decline in the number of funds in the industry as a whole. The number of hedge fund dissolutions actually fell in 2014 for the first time since 2010. Just 864 funds closed their doors in 2014, down from the 904 that ended their lives in 2013.
In 2010, the year in which the rise in liquidations began, 743 funds were shut. The difference between the birth and debt figures gives the level of population increase, which is still in the positive in 2014. The overall industry grew by 176 funds in 2014.
Performance breakdown by asset size
A greater search for risk control isn’t the only reason that hedge funds prefer to invest in larger hedge funds. According to the HFR report hedge funds with assets under management of more than $1 billion posted an average gain of 5.03% for the full year 2014. Small funds, with less than $50 million in assets, managed to add just 2.11% by performance.
Medium-sized performed just as well as large funds, even edging them out on average. Those funds, measuring assets between $250 million and $ billion, managed to grow by 5.16% during the twelve months.
The remaining group, those with assets of between $50 million and $250 million managed to grow their holdings by 3.66% during the period. Funds with more than $1 billion have outperformed all other categories on an annualized basis for the last three, five and ten year runs according to the report.
Fees keep falling
Another negative for the industry, the research found that fees are falling across the hedge fund industry on the back of enhanced competition and increased pressure on cost cutting. Average management fees fell by 3 basis points through the year to finish at 1.51%, while performance fees now average 17.8%, down 4 basis points from 2013.
The drop in fees may not seem dramatic, but with total capital in the industry measured at $2.85 trillion by the report, a 3 basis point compression amounts to a total of $85.5 billion lost by the industry as a whole.
Compression of fees is likely to continue as increased use of computer models reduces staffing levels, and competition reduces the rewards for smaller managers.