Emerging manager hedge funds can provide a unique set of advantages to institutional investors, including the offer of greater returns, access to a larger opportunity set, exposure to specialized investment processes and an increased willingness to negotiate fund terms and conditions with investors. However, despite these factors, investor interest in first time funds is declining in the midst of an evolving hedge fund industry, creating a more difficult environment for emerging managers to compete and survive within.
There has been an overall reduction in investor appetite for emerging managers among institutional investors since 2010. In 2013, 38% of institutional investors had an appetite for investing with emerging managers, compared to 42% in 2012. This continues the downward trend, with 48% having allocated to emerging managers in 2011 and 54% in 2010. Following the financial crisis of 2008, and the contraction of the hedge fund industry that followed, investors have begun to perceive safety in numbers, viewing funds from larger established firms as less risky.
2013 saw the fewest number of hedge fund launches since 2008, and the worst year in terms of hedge fund closures since 2009. According to Preqin’s Hedge Fund Analyst online service, there were 833 hedge fund launches in 2013, down from 1,187 and 1,122 in 2011 and 2012 respectively. These figures point to a market environment which is more difficult for start-up hedge funds than it was previously.
Despite increases in fund closures, hedge fund industry assets continue to grow. In 2013, industry assets surpassed $2.6tn, increasing by more than $360bn over the year from $2.3tn at the end of 2012. Just 3.3% of all active hedge fund managers control 43% of total industry assets, suggesting that a larger proportion of hedge fund assets under management are in the hands of a few of the world’s largest firms. This dynamic of increasing industry assets and a decreasing number of new funds to compete for said assets may indicate that investors are consolidating capital with the largest and most established managers at the expense of start-ups and emerging managers.
With the rise of ’40 Act’ mutual funds from hedge fund managers seeking to enter the retail investment market, offering higher liquidity and lower investment minimums, we see large established managers responsible for the majority of fund launches. However, emerging mangers may be able to utilize this avenue as a potential new source of capital, with sub-advising offering access to institutional investor commitments indirectly. Furthermore, Preqin’s Hedge Fund Investor Profiles online service shows that 54.1% of investors are willing to consider investing with emerging managers going forward, presenting newer funds with the opportunity to attract capital from institutional investors. With the potential for ’40 Act’ funds to open the door to new investors that would not have considered illiquid hedge fund investments, emerging managers may be able to begin reversing the decline in inflows by taking advantage of this new fund structure and market.