June 29, 2005

Victim of Its Own Success?

Capacity becoming an issue in hedge fund industry

Are hedge funds becoming victims of their own success? Barry Rosenstein, founder and managing partner of JANA Partners in New York, a $4 billion event-driven fund, told attendees of MARHedge's Mid-Year Institutional Investment Conference what he said was an "amazing" story. "I met a guy yesterday," he told 245 people gathered in San Francisco, "and he wasn't managing a hedge fund!" Rosenstein's tongue-in-cheek remark reflects the fact that all sorts of investors are looking to put money into hedge funds; he said there is already $1 trillion invested in 8,000 hedge funds. Another speaker at the conference, Meredith Jones, research director of Memphis-based Strategic Financial Solutions, said her research turned up 5,500 individually managed hedge funds. The challenge for managers, the consensus seems to be, is to not only find the alpha that will satisfy institutional and individual fund investors, but also to distinguish themselves from their thousands of brethren. Funds of funds might be the solution for many investors who wish to invest in hedge funds, since that approach limits volatility and provides diversification, but by their very nature the FoF doesn't provide the same amount of absolute return as does a single-strategy fund.

For investors, the challenge is also to conduct enough due diligence to understand the manager's strategy, which can be particularly daunting when dealing with the board of a pension fund or endowment that may not be all that familiar with alternative investments at all.

While the solution to those quandaries remains illusive, in his keynote address Rosenstein said that hedge fund managers like himself have an opportunity to play a big role in maximizing shareholder value through corporate activism. That's a good thing for shareholders, he said, suggesting that just as the corporate raiders of the 1980s set the stage for the corporate rebounds of the 1990s by forcing their targets to become more efficient and to trade at higher multiples, hedge funds could play a similar role in forcing companies in which they've invested to do the right thing for shareholders, not management.

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