Friday, 9 April 2010

Fund of Hedge Funds Consolidation: The gun has been fired

For just about all of the last decade it has been consistently suggested that the fund of hedge funds sector was just about to consolidate.


Industry watchers suggested that the three different size categories had very different profiles - as potential acquirers and takeover targets. The medium-sized players were going to snap-up their smaller brethren. The larger players were going to add to their assets under management by picking up medium-sized funds, and small funds of funds looked out-moded and should merge or fade away, so it was said and written.

The rationale for consolidation had several arguments:-

  1. The industry was mature, as shown by the declining average fees charged.

  2. Assets under management in funds of hedge funds as a percentage of the whole hedge fund industry peaked as long ago as the middle of 2008.

Graphic 1. Global Fund of Funds Industry








  









Source:IFSL estimates

   
3. In 2009 the attrition rate amongst funds of funds was twice the rate of single manager funds at times.
  
4. The costs of being in the business were on the rise as staff remuneration and the costs of compliance were only going up.
  
5. Institutional investors were increasingly dominating flows into the industry, and only large scale fund of funds organisations looked of institutional quality.
  
6. Brand names and critical mass were important to institutional investors and furthermore this client base required high-end (and therefore expensive) risk management systems and risk management professionals.
 
7. Assets are still leaving funds of hedge funds - according to TrimTabs they lost $17.4 billion in the three months to February 2010. 

In short, for five years it has been widely held that the margins of funds of hedge funds could only contract, and that the prevailing business models couldn’t be sustained.

In such an environment it became logical for founders of businesses, particularly of the boutique “family-office-plus”, to sell out and capitalise on the growth of their funds of funds businesses. But somehow it never quite happened to the extent expected.

However, a coincidence of recent events suggests that maybe, at last, we are about to see some M&A activity amongst funds of hedge funds. Here is a sample of some of the recent deals done.

In the last year

In January 2010 the Swiss based quoted multi-strategy firm Gottex bought the three Constellar funds of funds run by Ted Wong. The assets under management, at $150m, were not significant relative to the rest of Gottex, which manages over $8bn, mostly in market-neutral products. But they diversify the product mix into directional multi-strategy funds of funds offerings and, maybe more significantly, increase the firm’s knowledge of the US onshore and offshore markets.

Serial acquirer Aberdeen Asset Management has added to its string of acquisitions of long-only businesses by acquiring some alternative asset management contracts. In November of last year Aberdeen picked up the management contract for Bramdean Alternatives, giving it an opportunity to look at the fund of hedge funds business at close hand. It must have liked what it saw because in February 2010 Aberdeen paid £84.7 million to RBS for assets under management of £13.5 billion (as at 30 September 2009), comprising an established, award-winning fund of hedge funds business (that of Coutts), a long-only multi-manager business and certain private equity and real estate funds of funds. Aberdeen has built good distribution, and plugging-in alternative investment strategies should further diversify the revenue streams, and the fund of funds product can be pushed into existing channels when appropriately packaged.

It is true that the long tail of fund of hedge funds businesses has shrunk somewhat in the last 18 months. Ansbacher left the business, as did Commerzbank via its COMAS subsidiary, and tiddlers like Collingham Capital Management undertook an organised retreat from the business.

Several hedge fund firms ran in-house funds of funds that they hoped to commercialise, following the template of Renaissance Technologies’ Meritage Fund, the West Coast fund of funds that was founded to invest partners’ capital in single manager hedge funds. But these “natural extensions” of the business can find it as hard as unconnected funds of funds to get traction. For example, London based money manager Millennium Global closed down its small fund of funds run by Hamlin Lovell in the middle of last year, and Brevan Howard had a good-hard-look at entering the fund of funds business before deciding against it in 2009.


In the last month

That hesitation shown by Brevan Howard has been overcome by a couple of buyers of fund of funds businesses in the last month. First, Collins Stewart, the stockbroking and wealth management firm, has bought discretionary investment management firm Corazon Capital which has £382 million in assets under management with offices in Guernsey and Geneva. Corazon Capital was itself a management buy-out from Dawnay Day in 2008. Curiously the deal with Collins Stewart has been done for only £1m cash paid. As much as a further £6m worth of shares could be paid as the balance of the consideration over three years, dependent on performance in the next 12 months. In January 2009 Corazon had $1.2bn AUM, so the shape of the deal may be explained by the drop in assets alone. As for strategic rationale, Collins Stewart has long had a Guernsey presence and a small Geneva office itself, so there is a clear scope to reduce costs – as long as they hold onto the assets.

Second, and maybe the larger surprise of the two deals announced for funds of funds last month, was the purchase of a 75.1% stake in Aida Capital by Standard Life Investments. Aida Capital is a London based, FSA registered, fund of hedge funds manager. Aida currently manages the Aida Open-Ended Fund, a Guernsey listed investment vehicle and the Aida Closed-Ended Fund, an investment fund listed on the London Stock Exchange. In total AUM at Aida are around $50m, whilst Standard Life manages around $207bn. A “modest upfront fee” will be paid for the stake. At that scale it is all upside for Standard Life – it will have access to a wider range of alternative investments than before, and new fund of hedge fund products will be created specifically for Standard Life, which may be distributed through recognised life company channels. It is also open for the life company assets to be invested in funds of hedge funds, particularly when the issues of legal structure are resolved in the UCITS III format.

Neither of the two deals done last month, nor the deals done over the last year in the fund of hedge fund sector are large or involve major firms in the business. So how can there be an idea that the starting gun has been fired for acquisitions of fund of hedge fund businesses? It is partly the passage of time from the financial disaster of the 2H of 2008, and the condition of the financial markets now, and the turnaround in flows to hedge funds. Unlike during previous rallies from bear market lows in the early Noughties there are now hedge fund businesses with listings. The value of their shares as takeover currency has been rising, and a number of them have existing fund of hedge fund businesses. Merger and acquisition activity was muted last year but has risen this year in other sectors: as market levels have risen so entrepreneurial spirits have been able to get funded. The same should apply to quoted alternative asset management and hedge fund businesses.

The flows into single manager hedge fund businesses re-started in the middle of last year. The sales cycle for funds of funds is longer than ever, but the commitment of institutional investors to their hedge fund investment programmes should mean that funds of funds will see positive flows on a net basis by the middle of this year. And so top line growth is an additional consolidation driver. There is also scope to do deals to leverage a fund of funds infrastructure that has a lot of capacity for capital growth and margin expansion, like Aida Capital.

So there are a number of motivations and corporate strategies at play in the new environment for takeovers of funds of funds businesses. The gun has been fired.


The bulk of this article first appeared on The Hedge Fund Journal website

1 comment:

  1. good article. hard to find information on this sort of thing.
    -mike

    ReplyDelete