Skip to main content
MENU
Subscribe
  • Subscribe
  • Account
  • LOGIN
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE Act 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2022 Retirement Income Conference
    • 2022 Managing Pension Risk & Liabilities
    • 2022 WorldPensionSummit
Breadcrumb
  1. Home
  2. Print
December 27, 2004 12:00 AM

Small firms to play big role in hedge fund M&A

Consolidations to swap independence for infrastructure

Christine Williamson
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    NEW YORK — The hedge fund industry is due for a big shake-up in the next couple of years as small firms with paltry assets under management exchange independence for infrastructure and distribution.

    That's the view in a report on hedge fund merger and acquisition activity scheduled for release early next year by investment bank Freeman & Co. LLC, New York, which strongly suggests a surge in hedge fund consolidations.

    By contrast, a pair of investment bankers who specialize in alternative investment management deals — Ted Gooden and Torjus Berge, vice presidents at Berkshire Capital Corp., New York — are less convinced the shake-up will manifest as outright consolidation among hedge funds. Instead, Messrs. Gooden and Berge predict that a range of partnership structures will be set up as larger hedge funds buy up revenue stakes in promising startups, firms take equity stakes in each other to gain distribution clout, and hedge fund-of-funds managers hit a brick wall in terms of profitability.

    In fact, the Berkshire duo thinks it far more likely that consolidation will take place among unprofitable hedge fund-of-funds managers than between hedge funds themselves.

    Sweeping in scale

    But in Freeman's latest report, authors Eric C. Weber, principal, Olga Freidzon, associate, and Frank Reynolds, analyst, think hedge fund consolidation will be sweeping in scale.

    Seven hedge fund acquisitions, with $9 billion in total assets under management, occurred in 2004, compared with 2003, when only three hedge funds changed hands.

    The deal flow, still admittedly just a trickle, will likely trend sharply upward, said the report's authors, as small hedge fund managers come to terms with their limited chances of commercial success and sell their firms to gain scale and liquidate their ownership.

    In fact, small is the norm at this stage in the hedge fund industry's development, according to the report, which estimates that 70% of the world's approximately 8,000 hedge funds manage less than $100 million.

    The problem is that hedge fund companies that can't attract sufficient assets are very vulnerable to performance volatility, which is compounded by a lack of investment strategy diversification, according to the report.

    By way of example, the authors note that a hedge fund that charges investors a management fee of 1% of total assets and 20% of profits, and returns 10%, receives two-thirds of its annual revenue from performance.

    "This high dependency puts a small firm under extreme pressure if performance is low or negative," the report stated. "Small hedge funds that face even two difficult years may witness their revenues erode significantly and may not be able to cover their operating expenses or retain talented professionals. This will force many to consider partnering with a larger organization that will be able to support the manager until performance returns."

    Another problem

    Further compounding the problem for smaller firms is that negative performance and a subsequent decline in assets under management will make it even harder to raise more capital from new or existing investors. Because most small hedge fund companies offer one investment approach, they are left at the mercy of the markets when their strategy is out of favor.

    Other problems unique to smaller hedge funds, according to Freeman researchers, include:

    • Compensation challenges for key personnel, especially during cash-flow crunches;

    • Operational issues such as scarcity of resources to support marketing, compliance, administration, systems and technology and investment research;

    • Rising costs for compliance when new Securities and Exchange Commission regulations become effective in February 2006; and

    • Investor concerns about small hedge funds, ranging from lack of infrastructure to name-brand recognition to operational and compliance risks.

    With hedge funds of funds now controlling an estimated 40%, or $478 billion, of total hedge fund industry assets, Freeman researchers decided to use these firms as a kind of proxy for institutional investors and asked 20 firms about their comfort level with hedge fund size.

    Losing confidence

    Freeman's survey found that 40% of hedge fund-of-funds respondents start to lose confidence in hedge fund managers managing less than $50 million; and a much smaller group, 15%, said they would not invest in a hedge fund managing between $50 million and $100 million. Hedge funds of funds surveyed only invested an average of 4% of their assets in funds managing less than $50 million. Just more than 80% of those surveyed said they were worried about the lack of infrastructure; more than 60% are concerned that small hedge fund portfolio managers have to devote significant attention to business operations; and 50% said they were concerned that smaller hedge funds are too dependent on key personnel.

    The authors of the report also found that most hedge fund-of-funds managers are reasonably comfortable with merger and acquisition activity among smaller hedge funds, which is good, considering the merger mania the authors expect to see within the next few years.

    Deals Freeman analysts expect to see among larger hedge funds include acquisitions of smaller firms that use different investment strategies in order to broaden their internal ability to offer multistrategy funds. Large financial service companies that don't currently offer hedge funds are also on the acquisition trail in order to add them to their product mix. Freeman researchers said they definitely expect larger financial institutions to follow the lead of JPMorgan Chase & Co., New York, which last year acquired hedge fund manager Highbridge Capital Management LLC, New York.

    The investment bankers at Freeman also expect some consolidation among smaller hedge fund managers as multistrategy hedge fund platforms become more common and allow hedge fund managers to use pooled resources such as fund administration, marketing and information technology.

    Rather than outright consolidation of the kind predicted by Freeman researchers, Berkshire's Messrs. Gooden and Berge predict that poor returns and the gradual institutionalization of the hedge fund industry will cause a huge increase in collaboration among hedge fund managers.

    While many industry observers predict consolidation among hedge fund companies, Mr. Gooden said what's happening "very under-the-radar-screen because these are private deals" is "partnering" between the talented investors at hedge fund startups and larger, more established hedge fund managers.

    "Bigger firms are redeploying some of their capital to gain revenue shares in smaller funds with different skill sets. It's really the capital side of the business at work: Smaller firms want trading capital that can help them get up to that critical $150 million under management, the magic number where institutional and other investors will start to look at them," said Mr. Gooden.

    In talks

    Mr. Berge said Berkshire is in talks with many companies on both sides of these revenue-sharing deals.

    In addition, he said, larger hedge fund firms are striking cooperative deals with other hedge fund managers that have different skills sets, mainly to gain access to each other's client lists. While these deals are structured in many ways, Mr. Berge said most long-term deals involve an exchange of equity.

    The hedge fund-of-funds niche is the one area where true consolidation is inevitable, Mr. Berge said. "The hedge funds-of-funds world is about to change dramatically," he said.

    By Berkshire's estimates, hedge funds of funds with less than $2 billion under management are likely destined for extinction because of fee pressures and lack of scale. Berkshire estimates that at least 500 hedge funds of funds are simply not viable concerns going forward.

    "Let's say you've got a $1 billion hedge fund of funds, with 40 employees necessary to do all the due diligence, research, compliance and sales and marketing needed to sell the funds. You simply aren't going to make enough money to cover all the overhead. You have a job, but you don't have a going concern," Mr. Berge said.

    Messrs. Gooden and Berge said they've seen an enormous increase in the amount of dialogue between hedge fund-of-funds managers on all continents as they realize that they require scale to survive. "We expect a lot of consolidation activity in this space in the next two to three years," said Mr. Gooden.

    Recommended for You
    Read the print edition of P&I
    Read the print edition of P&I
    How low is low? Projections say it's not low enough
    How low is low? Projections say it's not low enough
    FINRA honors Wharton's Olivia Mitchell with Ketchum Prize
    FINRA honors Wharton's Olivia Mitchell with Ketchum Prize
    Emerging Markets: A Selective Approach
    Sponsored Content: Emerging Markets: A Selective Approach

    Reader Poll

    June 6, 2022
    SEE MORE POLLS >
    Sponsored
    White Papers
    Nearing the finish line: Ideas on end-state investing for corporate DB plans
    The Meaning of "Portfolio Intelligence"
    Credit Indices: Closing the Fixed Income Evolutionary Gap
    Forever in Style: Benchmarking with the Morningstar® Broad Style Indexes℠
    Crossroads: Politics, Inflation, & Bonds
    Is there a mid-cap gap in your DC plan?
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    June 20, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2022. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE Act 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2022 Retirement Income Conference
      • 2022 Managing Pension Risk & Liabilities
      • 2022 WorldPensionSummit