While 2014 saw a near-record number of hedge funds close their doors, experts predict the industry’s extinction rate will be even higher this year. It will be especially tough for the small guys.
The mid-sized hedge fund may soon become an endangered species, if one set of predictions for the year ahead prove correct. Hedge funds of all sizes closed their doors in what is expected to be near-record numbers last year, and industry observers believe that will continue — and maybe even accelerate — in 2015.
According to hedge fund marketing and research consultancy Agecroft Partners, in 2015 more hedge funds will shutter than in any other year since the financial crisis. Agecroft pins the closures on four main factors: the hedge fund pool has grown too large, with an estimated 15,000 funds currently operating; a lower quality of returns will trigger redemptions; increased volatility in the markets will increase the divergence of returns between different managers; and small and mid-sized managers will be shunned by investors looking for a big name to look after their money.
“It’s not money leaving the industry, because assets are up,” Don Steinbrugge, founder of Agecroft told BuzzFeed News. During the financial crisis in 2008 and 2009 a record number of hedge funds closed, with industry assets contracting by 40% — 18% of which was due to performance and the other 22% due to redemptions.
“The difference between 2008 and today is hedge fund assets are close to their all-time peak, so when assets leave a hedge fund, the money is typically reinvested in another hedge fund,” Steinbrugge said.
Not that this is necessarily a bad thing. Assets industry wide are up at an alarming rate. The hedge fund industry crossed the $3 trillion mark last year, and according to a new study from research firm eVestment Alliance, “barring a large and unexpected global or financial event, hedge funds should see at least between $90 billion and $110 billion of new asset flows in 2015, keeping hedge fund industry AUM above $3 trillion, a milestone the industry passed in mid 2014.”
So it’s not that investors are pulling their money altogether from hedge funds, it’s just that they are reallocating it to other funds, something that has hit — and will continue to hit — the smaller managers the hardest.
“It has become increasingly difficult for managers sub-$200 million in assets to raise money, even if they have a very high quality product, because most of the money has been flowing into hedge funds with the strongest brand and the most assets under management,” Steinbrugge said. “There’s only so long you can operate until you give up. Most of them have enough capital for three to five years until its just not worth the effort for them.”
Indeed, in 2014, fund closures were on track to hit the highest number since the financial crisis, with Hedge Fund Report, a data and analytics consultancy, finding that through the third quarter, there were 661 funds that liquidated. That puts the hedge fund industry on pace for the highest number of closures since 2009, when 1,023 funds shut down. The year before, more than 1,400 hedge funds closed.
While 2015 might not be that dismal, Peter Laurelli, VP and head of research at eVestment Alliance, told BuzzFreed News there will likely be a high number of closures due to the changing demographics of the typical hedge fund investor, which will also cause small and mid-size funds to be hit the hardest by redemptions.
“The process is a natural refinement of a maturing industry,” Laurelli said. “Asset levels rose last year to higher levels than 2007, and it wasn’t performance. It fits the idea that there are few funds that are getting money. One of the things that’s driving this is the shift of the investor base from high-net-worth and fund of funds to a very institutional investor base, and it’s expensive to operate with the right systems in place to attract institutional money. If not, you don’t have the money to keep the door open.”
In Steinbrugge’s opinion, some of the closures may be a result of personal decisions on the part of hedge fund managers themselves. Even if enough money is coming in to keep the lights on, the personal toll the job can take could lead to many managers deciding to shut their operations down for good.
“My sense is that running a hedge fund takes tremendous dedication and requires the manager to put running the portfolio ahead of family life,” Steinbrugge said. “It requires a hedge fund manager to make managing the hedge fund their number one priority in life, and you can only do it so long before you began to question is this sacrifice worth it. If the hedge fund starts taking off, then your motivation level and compensation increases, but if you’re stuck at the same asset level and barely making a profit, then you have to question whether it’s worth the effort.”