Current Investor Appetite for Emerging Hedge Fund Managers - October 2012

by Graeme Terry

  • 09 Oct 2012
  • HF

Hedge funds managed by new and emerging managers can be attractive to investors, as such funds are often more nimble and can provide a larger opportunity set and a more streamlined decision-making process. However, investing in emerging managers is often perceived to be riskier than investing with established managers due to the lack of track record. Interest in emerging managers among institutional investors appears to have been declining in recent years, but there remains an appetite for such funds. Preqin currently tracks over 950 investors with an interest in emerging funds.

A previous Preqin study in December 2011 indicated that 83% of investors in emerging manager hedge funds allocate to emerging managers due to their potential to offer stronger returns. Other reasons for investors targeting emerging managers include an ability to negotiate better terms, access to new strategies, a greater alignment of interests between manager and investors and the fact that emerging managers can offer long-term investment prospects. First-time funds continue to attract the most attention amongst institutional investors with 42% of investors on the Preqin database willing to commit capital to these vehicles. This figure has shown a steady decrease from 54% in 2010 and 48% in 2011. Interest in hedge funds managed by spin-off teams has also dropped over the previous year from 43% in 2011 to 38% in 2012 whilst the proportion of investors interested in seeding new hedge funds has declined from 21% in 2011 to 19% in 2012.

Investors in emerging hedge fund managers are most commonly those with a large capital base and strong investment resources. As a result, it is unsurprising that funds of hedge funds remain the most likely to invest in small and emerging funds, with 70% of these investors showing an interest. Asset managers are another group targeting emerging hedge funds, with 50% of these investors indicating an interest. Fifty percent of endowments also find emerging manager hedge funds attractive, although this has declined from 65% in 2010 and 58% in 2011 as these investors try to reduce risk in their portfolios. Family offices have shown a slight increase in appetite for emerging manager hedge funds over the previous year from 44% in 2011 to 47% in 2012. These investors are often willing to take more risk, and small funds can appeal due to their potential for greater diversification, stronger returns, and flexible fund terms. Pension funds have traditionally been more conservative hedge fund investors and, as a result, they are less likely to allocate to emerging managers.

The last two years have been difficult for emerging managers trying to raise capital, with interest in emerging manager hedge funds among institutional investors showing a steady decline. However, there are still opportunities for emerging hedge funds and these managers can attract investors by offering better fund terms, access to niche strategies and a greater alignment of interest with the manager. The most common reason for investors allocating to emerging managers is the potential for stronger returns, which makes it important for fund managers to convince investors they have the set-up and personnel to deliver consistent positive returns.

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