The Crash of the Titans
"The war of the giants has ended; the quarrels of the pigmies have begun."
Sir Winston Churchill (1874-1965)
U.K. Prime Minister
One clear comment that can be made in the light of the extraordinary events that have unfolded since the summer of 2007 is that in hedge fund world Big is Not Beautiful - anymore!
Today, it seems that the larger the hedge fund the more susceptible it has been to redemption flight risk. This is what can be expected in a world in which liquidity mismatches were the norm and where beta was produced in abundance but in a grossly correlated manner.
Those larger funds managed to generate an estimated additional 260 bps of extra performance per year from 2000-2006 versus the average hedge fund as defined by the Credit Suisse/Tremont Hedge Fund Index. In this case, a big fund had assets under management of over US$6 billion as of 2000. In fact, the top quartile performers actually produced over 650 bps more per year in the elusive "alpha" per year versus their hedge fund brethren.
It was a time of plenty. The biggest institutional investors recognized it and the managers themselves saw it. The party roared on, and as it did, the prime brokers also enjoyed the gains. In fact, they helped keep the spigot of leverage, stock loans and deal flow going to the funds very often reducing the execution and cost of capital costs for these big players by as much as 250-300 bps per year! Now that is what I call alpha! Many of these fund managers fell into the trap of growth for growth sake lured by ever attractive management fees under the mantra of diversification. Even the investors bought into this marketing pitch.
The fact is that ever manager knows that the best time to invest in a hedge fund is when the manager is in his "emerging" phase. This is the time he is really focused on alpha, getting the highest performance and keeping operational costs lean. He/she is hungry but typically too small or not institutional enough for pension plan investors who have US$10 million slugs to go followed by US$20-50 million slugs every six months.
Size can help the manager operate anonymously, not leaving a trading trail for brokers to front-run or other managers to poach off of! This was the sad turn of events that tripped up so many of the big multistrategy funds in the Fall of 2008 when an incredible number of them were in the same "short financials-long commodity" trade. It collapsed miserably and exposed the hedge fund industry for all its faults.
Today, investors in Asia and elsewhere are disillusioned with hedge fund industry performance, risk management and all of the other institutional-quality benchmarks which appeared to break down. That there will be a cleaning out of the single manager field is always an issue. In normal times Asian managers suffer a 8%-12% mortality rate, but in 2008 this figure will likely hit 35%-50%. The damage to hedge fund of funds may be even greater. But as the words of Martin Charnin in a famous musical go: " The sun will come up tomorrow"!
We have all learned that big is no longer beautiful. Investors appear to recognize this and are punishing the share prices of publicly traded hedge fund shops like Sparx. Mahalo!
"The war of the giants has ended; the quarrels of the pigmies have begun."
Sir Winston Churchill (1874-1965)
U.K. Prime Minister
One clear comment that can be made in the light of the extraordinary events that have unfolded since the summer of 2007 is that in hedge fund world Big is Not Beautiful - anymore!
Today, it seems that the larger the hedge fund the more susceptible it has been to redemption flight risk. This is what can be expected in a world in which liquidity mismatches were the norm and where beta was produced in abundance but in a grossly correlated manner.
Those larger funds managed to generate an estimated additional 260 bps of extra performance per year from 2000-2006 versus the average hedge fund as defined by the Credit Suisse/Tremont Hedge Fund Index. In this case, a big fund had assets under management of over US$6 billion as of 2000. In fact, the top quartile performers actually produced over 650 bps more per year in the elusive "alpha" per year versus their hedge fund brethren.
It was a time of plenty. The biggest institutional investors recognized it and the managers themselves saw it. The party roared on, and as it did, the prime brokers also enjoyed the gains. In fact, they helped keep the spigot of leverage, stock loans and deal flow going to the funds very often reducing the execution and cost of capital costs for these big players by as much as 250-300 bps per year! Now that is what I call alpha! Many of these fund managers fell into the trap of growth for growth sake lured by ever attractive management fees under the mantra of diversification. Even the investors bought into this marketing pitch.
The fact is that ever manager knows that the best time to invest in a hedge fund is when the manager is in his "emerging" phase. This is the time he is really focused on alpha, getting the highest performance and keeping operational costs lean. He/she is hungry but typically too small or not institutional enough for pension plan investors who have US$10 million slugs to go followed by US$20-50 million slugs every six months.
Size can help the manager operate anonymously, not leaving a trading trail for brokers to front-run or other managers to poach off of! This was the sad turn of events that tripped up so many of the big multistrategy funds in the Fall of 2008 when an incredible number of them were in the same "short financials-long commodity" trade. It collapsed miserably and exposed the hedge fund industry for all its faults.
Today, investors in Asia and elsewhere are disillusioned with hedge fund industry performance, risk management and all of the other institutional-quality benchmarks which appeared to break down. That there will be a cleaning out of the single manager field is always an issue. In normal times Asian managers suffer a 8%-12% mortality rate, but in 2008 this figure will likely hit 35%-50%. The damage to hedge fund of funds may be even greater. But as the words of Martin Charnin in a famous musical go: " The sun will come up tomorrow"!
We have all learned that big is no longer beautiful. Investors appear to recognize this and are punishing the share prices of publicly traded hedge fund shops like Sparx. Mahalo!
posted by Franklin Scruggins | 2:27 PM
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