By Lydia Tomkiw
The hedge fund industry is known for many births and deaths, and the odds of a fund launching, surviving, and thriving are tough. But just how difficult is it?
FundFire examined a 2015 Goldman Sachs emerging managers capital introduction conference document, which featured nearly 30 emerging managers that launched new funds between 2013 and 2015. FundFire did not count funds housed within an already established hedge fund manager or other financial institution. The list of funds – spanning strategies such as event driven, credit, and equity long/short – provides a microcosm through which to view the hedge fund universe and to grasp the challenge of launching a fund, growing assets, and surviving for even a few years.
Five years later, approximately 45% of the hedge funds in the document had terminated their filings with the Securities and Exchange Commission, meaning they either closed down or had assets drop below $150 million – or never rose to that level.
Two funds – Hollis Park Partners and Nitorum Capital – manage over $1 billion in assets, according to their most recent filings with the SEC. And a handful of funds were managing between $300 million to $1 billion including Column Park Partners, Banbury Partners, and Sentinel Dome Partners, according to public filings.
A handful of funds were filing with the SEC as an exempt reporting adviser, meaning they manage below $150 million in assets.
Performance is the number one factor for a firm to survive early on, says Jim Cass, founding member at Hidden Crest, a consulting firm focused on alternatives. Additionally, many new launches have not run a business before and need to focus on an operating model that keeps business expenses low.
“The three- to five-year performance track [record] is really the make or break for a lot of these firms,” he says. “Can you justify how much you are paying that manager for that performance? That’s always been a make or break factor for hedge funds.”
And not all funds are trying to cross the $1 billion in assets under management mark, Cass says, because some strategies run more efficiently at a lower amount.
The failure rate for start-up hedge funds is “pretty high,” says Gary Berger, financial services industry leader for the Northeast at CohnReznick. And fundraising is the “the most important thing to get a fund going,” he says.
But today that is an even more difficult path. The pandemic-fueled economic environment is having an impact on managers’ ability to fundraise, as well as on investors’ ability to conduct due diligence on funds, delaying or reducing the amount of capital they can allocate, Berger adds.
“COVID-19 has put the spotlight on it and made it more difficult,” he says. “People will do whatever it takes to launch a fund now. Friends and family investments are very common.”
The launch environment has changed greatly in the past 10 years and a manager can no longer expect to pick up the phone and call allocators and obtain seed capital, says Tim Ng, CIO at consultancy Clearbrook LLC. Allocators also face challenges with launches, which require extra due diligence effort, including questions about whether managers can grow and their potential to survive past three years, he adds.
All this comes at a moment when the market’s largest hedge funds continue to control the majority of industry assets. Hedge funds with $5 billion or more in assets represent approximately 5% of all managers in the market but control over 63% of all industry assets, according to the latest figures from Hedge Fund Research.
“There’s not a lot left for all of the other managers,” Ng says. “It has now gotten worse and is exacerbated by the COVID situation.”
But the post-pandemic environment could also offer more flexibility to start-up managers, says Mark Aldoroty, head of prime services and collateral funding and trading at BNY Mellon’s Pershing fund services unit. “Running it from your home will become more acceptable than it had been in the past,” he says.
And investors still are open to smaller managers. Sixty-nine percent of investors reported that the characteristics of a smaller boutique manager appeal to them and only 26% reported that a minimum 10-year track record appealed to them, according to the results of Pershing’s Prime Services investors flash poll conducted in May, based on responses from 54 professional investors.
“Start-ups are still going to be incredibly viable. Like anything else there will be a portion that will be successful and a portion that won’t,” Aldoroty says.