December 3, 2013

Investors Shying From First-Time Hedge Fund Managers

Wary of volatility, institutional investors look for longer track record

Investors in emerging hedge fund managers’ first funds tend to enjoy higher returns than if they had allocated to a new fund managed by an established firm, according to alternative asset industry information provider Preqin.

However, first-time funds are more volatile than ones managed by experienced firms, and many investors are holding onto their money. Those interested in first-time funds has dropped to 38% this year, down from 42% of investors in 2012.

The average long/short hedge fund launched by an emerging manager since 2007 delivered annualized net returns of 8.8% in its first three years of trading, compared with an annual rate of 5.4% from new funds managed by established firms.

The average annualized volatility of returns during the three years following inception was approximately 14.7% for established manager long/short funds versus 17.3% for emerging manager long/short funds.

“With more first-time fund groups in the market than ever before, following the fallout of the Volcker Rule and revived optimism in the industry, finding the potential star of the next generation is an increasingly difficult task, and one many investors are unwilling to enter into,” Preqin’s associate commercial manager for hedge funds Graeme Terry said in a statement.

Terry said most investor groups were less willing than a year ago to consider emerging managers, and 71% were looking for a longer track record from managers before considering them for investment.

However, 75% of investors tracked by Preqin would consider smaller managers with less than $500 million under management, he said. More investors may have to do this as larger funds close to new investment upon reaching capacity.

The burden is on first-time funds to stand out in a crowded market, Terry said. “Emerging managers need to ensure that they have a strong team, robust infrastructure and a coherent strategy, as well as strong early performance in order to attract investment from the ever-demanding institutional community.”

The Preqin statement reported these other key facts:

  • 22% of emerging manager funds launched since 2007 recorded a loss in their first year of trading, compared with 26% of funds launched by established managers.
  • However, emerging managers that suffered a loss in the first year tended to experience larger declines.
  • 73% of these investors interested in emerging managers are fund-of-hedge-funds managers, followed by asset managers (46%) and family offices (43%).
  • 274 new hedge fund managers set up business in 2012, a record, and 2013 could eclipse this with 231 recorded manager launches as of Nov. 15.
  • 70% of hedge fund managers that launched in 2013 were based in North America, and 48% of all managers launching used a core long/short strategy.
  • Despite an increase in hedge fund manager launches in 2013, only 44% of new fund management groups have launched their first vehicle—604 recorded as of Nov. 15.  
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