Mid-Size Hedge Funds Face Strategic Squeeze
"All things being equal, people will buy from a friend. All things being not quite so equal, people will still buy from a friend."
Mark McCormack, b.1930, Chairman and CEO, IMG
A recent takeaway from a curiously titled hedge fund conference in NY ("Battle of the Quants"), centered on the economies of scale enjoyed by large hedge funds. It was a nugget offered by the keynote speaker, David Mordecai of Risk Economics Limited.
According to Mordecai, basic economics are at work in the hedge fund industry. Tobin's Law states that abnormal rents earned will eventually be arbitraged away to the point where price will be equal to marginal cost.
He quoted data that pointed to the incredible cost/financing advantages enjoyed by the largest hedge funds in the business. Apparently, those single managers with AUM over US$5 billion now enjoy average cost advantages of at least 300 basis points. To get there he said one has to take account of the cost of short rebate, borrowing long against Fed Funds financing rate which together can amount to 100 basis points on the notional amount. This, together with a modest leverage assumption of approx. 2.5 or 3 to 1 produces the 300 bps implicit funding advantage. This is before the hedge fund even puts on any trades.
Add to that the anecdotal evidence produced by The Financial Times. They unearthed a situation where a prime broker was actually paying a big fund to do business i.e. the fund was being paid to do financing with the broker.
What does this mean?
Certainly, it means that the largest funds will continue to enjoy these advantages. In much the same way that they do in the U.S. and possiblly Europe, expect similar cut-throat financing competition to flow over to Asia (if it is not already taking place). Of course the exact definition of "size" among Asian hedge funds will have to be modifed for this argument to be transferable. For example, at the last count there were close to a dozen hedge funds with AUM over US$1 billion, and fewer still with AUM over US$5 billion that could be called "Asian" as opposed to being global - where most of the cosgt advantages currently reside.
Second, if big funds hold the proverbial negotiating hammer with prime brokers, the medium sized funds are getting squeezed. Not only are they typically not quite yet "institutional" in AUM or infrastructure but they cannot enjoy the financing advantages of their bigger rivals. So, their business model must try to decide whether to "go big" or "go niche". In the latter case, they might eke out alpha in smaller more exotic opportunities and situations which are likely to be size constrained. This is certainly the dilemma that they face wherever they are, especially if it relates to Asia.
Mahalo.
"All things being equal, people will buy from a friend. All things being not quite so equal, people will still buy from a friend."
Mark McCormack, b.1930, Chairman and CEO, IMG
A recent takeaway from a curiously titled hedge fund conference in NY ("Battle of the Quants"), centered on the economies of scale enjoyed by large hedge funds. It was a nugget offered by the keynote speaker, David Mordecai of Risk Economics Limited.
According to Mordecai, basic economics are at work in the hedge fund industry. Tobin's Law states that abnormal rents earned will eventually be arbitraged away to the point where price will be equal to marginal cost.
He quoted data that pointed to the incredible cost/financing advantages enjoyed by the largest hedge funds in the business. Apparently, those single managers with AUM over US$5 billion now enjoy average cost advantages of at least 300 basis points. To get there he said one has to take account of the cost of short rebate, borrowing long against Fed Funds financing rate which together can amount to 100 basis points on the notional amount. This, together with a modest leverage assumption of approx. 2.5 or 3 to 1 produces the 300 bps implicit funding advantage. This is before the hedge fund even puts on any trades.
Add to that the anecdotal evidence produced by The Financial Times. They unearthed a situation where a prime broker was actually paying a big fund to do business i.e. the fund was being paid to do financing with the broker.
What does this mean?
Certainly, it means that the largest funds will continue to enjoy these advantages. In much the same way that they do in the U.S. and possiblly Europe, expect similar cut-throat financing competition to flow over to Asia (if it is not already taking place). Of course the exact definition of "size" among Asian hedge funds will have to be modifed for this argument to be transferable. For example, at the last count there were close to a dozen hedge funds with AUM over US$1 billion, and fewer still with AUM over US$5 billion that could be called "Asian" as opposed to being global - where most of the cosgt advantages currently reside.
Second, if big funds hold the proverbial negotiating hammer with prime brokers, the medium sized funds are getting squeezed. Not only are they typically not quite yet "institutional" in AUM or infrastructure but they cannot enjoy the financing advantages of their bigger rivals. So, their business model must try to decide whether to "go big" or "go niche". In the latter case, they might eke out alpha in smaller more exotic opportunities and situations which are likely to be size constrained. This is certainly the dilemma that they face wherever they are, especially if it relates to Asia.
Mahalo.
posted by Franklin Scruggins | 4:09 PM
0 Comments:
Post a Comment
<< Home