Last year, 900 hedge funds were launched. This is the lowest number since 2010 and constitutes a drop of more than 60% from the highs experienced in the previous two years.1
I see four explanatory factors for this dip:
1. Private market investments taking the limelight
Whilst general sentiment was weighed down by the average hedge fund posting negative returns and both the equity and fixed income markets entering bear market territory, primary causes are to be found elsewhere.
A larger adverse impact was attributable to the relatively strong performance of private market investments (e.g. private equity, private debt and infrastructure). Despite various investor surveys highlighting institutional investors’ expectations of increasing allocations to hedge funds, many did not realize these projections2. Instead, they continued to favor private market investments when allocating to alternative investment strategies.
2. Cyclicality in the preference for emerging or established managers
Against the backdrop of strong performance from many larger multi strategy funds, big was beautiful in the eyes of many institutional investors (and their oftentimes risk averse investment consultants). Large and well-established funds were seen as the safer and more attractive bet, making it harder for emerging managers to attract seed money.
However, this has not always been the case. Finding the next George Soros among emerging hedge fund managers has, during certain periods, been a priority for allocators. There is a clear cyclicality to their preferences and the tide for emerging managers will surely turn again.
3. Multi strategy funds are the new fund-of-funds
With large multi strategy funds like Millenium, Citadel and Balyasny growing exponentially, a hiring spree is underway to add portfolio management teams. For many aspiring hedge fund managers wanting to strike out on their own, the ‘ready-made’ setup – oftentimes including sizable seed money – offered by the multi strategy funds is an attractive proposition. It enables them to focus almost exclusively on their core competence (and main interest) of generating alpha, while maintaining semi-autonomous operations.
On a side note, it is worth mentioning the ‘operational alpha’ impact. Investing is not only about having the best investment ideas, but also to possess an organizational setup which cost-efficiently exploits alpha opportunities across highly variable financial markets globally. Here, large multi strategy funds often have an advantage over their smaller peers.
4. Structural trend of quantification
In the wake of the Global Financial Crisis of 2008-09, an increased regulatory burden has made it more laborious and expensive to set up a hedge fund. These costs are being further compounded by the emergence of a new industry trend (constituting a high hurdle for many funds); quantification.
To keep their edge, hedge funds – particularly discretionary funds – need to embrace new technological advancements and increase the use of quant analytics in their investment processes. This applies to data management, research, signal generation, and trade execution.
Quantification demands funds invest in infrastructure and human capital. As a consequence, there is a strong outsourcing trend in the industry, with third party specialists enabling funds to efficiently access the required tech stack and domain expertise.3
Despite fewer hedge fund launches last year, the hedge fund industry is still growing. Given expectations that the current challenging market environment will persist, unconstrained investment strategies should be well-positioned to add value to institutional investors’ portfolios over the coming years. However, hedge funds must continuously evolve and innovate to maintain their edge.
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1Read more in the State of the Hedge Fund Industry report published by SigTech. Number of hedge fund launches based on data sourced from Preqin Ltd as per mid-January 2023.
2E.g. FUNDFire article and SigTech Institutional Investor Research Report
3SigTech Institutional Investor Research Report