Co-Opting Marketing Resources for Hedge Funds - Part Two

Preqin - Building On A Database 

The previous and following articles in this series cover lead generator companies in the hedge fund business who make great efforts to explain that they are not database companies. Preqin is a database company that is trying to add some value beyond that restrictive label, so is coming from a different direction from the other two series subjects, Murano Systems and Brighton House Associates.

Preqin provides data and information on the private equity, real estate, hedge funds and infrastructure sectors. The company started in London in 2002 by making efforts to track private equity information (hence the name) – deal flow, terms, funds, and investor activity. The market intelligence gathered was turned into publications and a database. It was the investor activity that led to Preqin collecting hedge fund related information – there was a lot of overlap among the investors in private equity and hedge funds.

Preqin collated the information the investors (investing institutions, endowments and family offices) gave them into their core hedge fund product, which is a database they call Hedge Fund Investor Profiles. Most alternative investment databases that are sold to marketers are lists of potential targets for the marketer’s product.  And the usual database/list/directory does not make much effort go beyond being a database of contacts.

A contact database typically would have a cursory company profile on a list of targets i.e. North American Family offices.  This data can be found in the public domain from phone directories to websites, and the value of a contact database is that a company or person has taken the time to gather up the data and break it into specific lists or categories.  The value is in the aggregating of the data.  The company profile might have a company name, address, phone number, general area of interest, perhaps some historical information, and the name of the acknowledged head of the organisation.

A Refreshed Contact Database

The Preqin hedge fund database is different from the typical directory-like contact database because it is refreshed on an on-going basis, and carries time-sensitive information. A directory of investor names you can buy relatively cheaply on the internet is an accumulation of all the information gathered to that point – it is a snapshot of standing data and information. Some of the information will be fresh, some will be quite ancient.

Preqin have a dedicated team of analysts proactively contacting industry professionals, monitoring regulatory filings, making FOIA requests and tracking news sources to make the their data and information on all firms, investors and service providers  up to date. The analysts speak to investors at least twice a year, and try to make contact with the larger investors four times a year.

The analysts ask investors in hedge funds what their investment plans are for the next twelve months.  There are two levels of interest captured on the database - actively looking now and tracking a strategy. The information held on the Preqin database is always first-hand, and because of the contact frequency, unlikely to be more than six months old.  This is important in a couple of regards – the investment strategies sought and followed will change over time, and the staff doing the seeking and following will change. Each month around 400 database entries are updated.

Then there is the breadth. Because of the resources applied – 25 to 30 analysts in total – and the period over which data has been gathered, Preqin has a database of investors in hedge funds which is as extensive as any. A directory or list of investor names by category might run to a few hundred fund of hedge funds or pension plans. The Preqin database has 3300 investing institutions, and the firm is currently adding 500 new names a year. For example, at the moment the firm is engaged in a project to identify and contact Foundations, in the process 70-80 names are being added each month.

Of the three providers covered in this series of articles Preqin has the most finely tiered offering by price. At the top of the range is the Premium version of Preqin’s Hedge Fund Investor Profiles.  This gives complete access to all data held for $4,250 p.a. and lists the name, type of investor, background, location, assets under management, current and target allocation to hedge funds, current areas of interest by location and strategy, description of investment plans and key contacts of the investing institutions.

Only the Premium product is downloadable to Excel or the in-house CRM of the client, and can be accessed by 5 users. The Premium product contains consultant information – who works for whom. This is considered essential information in the current hedge fund marketplace as a large part of the industry’s flows are now either mediated by a consultant or advised by consultants.  So hedge fund managers looking for the bigger tickets will buy the Premium version of the Preqin Investor Profiles. As it is, about 70% of Preqin’s clients for hedge fund products take the Premium product.

The Standard Access to Preqin’s Hedge Fund Investor Profiles costs $2,150 p.a. and it enables users to search for investors by location (e.g. list all endowments and foundations in Toronto, Canada), and find investors with specific investment plans (for example, ask who is interested in investing with hedge fund of funds). Another feature is that users can view investors by firm: that is, view which Investors have previously invested with particular hedge fund managers. This can help indicate the biases and investment style of potential clients. So a pitch can be tuned to the sort of thing that the potential investor is known to like, and the fund can be differentiated from unsuccessful investments in the past in the same investment style.

The Standard Access comes with a couple of compromises compared with the Premium Access service of Preqin. The database can be interrogated but not downloaded or linked to a CRM system, and only one user can access the database at a time.  The top-tier of investors on the database can be separately purchased in the form of the Preqin Hedge Fund Investor Review, which is an annual product. The 2012 edition features profiles and analysis for the 1,000 most important investors in hedge funds worldwide, and is keenly-priced at $795. The Review contains listings of investors with a preference for the 10 most important fund strategies.

Entry Level Products

Preqin offer a couple of entry level products: the Emerging Manager Download and the Fund of Funds download, both priced at a great value $1000 one-off cost.

The Emerging Manager Download contains contact details for over 890 institutions that have expressed an interest in investing in emerging managers, making the Emerging Manager Download an excellent way of targeting the high potential investors for a smaller fund. Investors include the full array of hedge fund of funds, public pensions, endowments and family offices and foundations. This Excel download contains details on nearly 3,000 specific contacts at investing institutions including name, position, e-mail and telephone number – sufficient to ensure a new hedge fund manager can contact at least a colleague of the relevant person.

Historically funds of funds have been the biggest allocators to hedge funds and are a necessary investor base for hedge fund managers to hit to raise capital. With the Preqin Fund of Funds download of over 600 allocators the marketer or PM of a hedge fund can searched by strategy, location and typical investment size to pinpoint the firms who may be interested in their vehicle.  The Fund of Hedge Funds Excel download contains contact details, including direct phone number and email address, for more than 2,300 individuals at the 600-odd multi-managers from around the world.  As the firms listed range in size from $10 million to $60 billion they will vary from the nimble to the lumbering, but filtering of the list by individual strategy, region and typical investment preferences tags should throw up a very workable long-list of potential investors.

Preqin has also recognised the increasing influence of consultants to flows in the hedge fund industry in its product range. The Premium version of Hedge Fund Investor Profiles contains consultant information, and in addition there is a dedicated product – the Preqin Alternatives Investment Consultant Review ($695). The 2012 edition contains profiles for over 350 different investment consultancy firms.

Consultant profiles within the Review contain information on the types of services offered, asset classes covered, key financial information, direct contact information for relevant contacts and details showing which consultants are being retained by 1,560 institutional investors from around the world. The review identifies key trends in the consultant universe plus information on the market’s make-up.  Of particular relevance for owners or marketers of single manager hedge fund businesses the Review shows which firms operate a buy-list, which firms consider first-time managers, and what they look for when considering new opportunities. The Review is also relevant to investing institutions looking to benchmark their current consultants or to investors considering the services of consultants.

The other directory-like product from Preqin is the Sovereign Wealth Fund Review, which costs $595 and provides a detailed analysis of sovereign wealth funds and their activity in all different asset classes. The Review contains useful analysis plus full profiles for over 60 sovereign wealth funds worldwide. Of all investors in hedge funds SWFs are perhaps seen as the most desirable – they have stable long-term capital, are professionally managed or advised, and can write very large tickets.

The first article in this series covered lead generator Murano Systems and the next article will feature Brighton House Associates. The final part will also draw some distinctions between the three and how they are positioning themselves, and so will come back to how Preqin is trying to compete more directly with the pure lead generators.

The End is Nigh for Smaller Funds of Hedge Funds

For some time there have been questions raised about the sustainability of the business models of funds of hedge funds as a category. There is no doubt that they will continue to exist and that there will be winners as well as losers. But the rising tide of assets in the hedge fund industry is not lifting all the FoF boats. Only this week quoted hedge fund company Man Group reported minor growth in its single manager businesses and minor shrinkage in its multi-manager business (see previous article).

There are solid reasons for the changing composition of the shape of the FoFs sector, mostly related to the source of the whole industry's net flows, i.e. American investing institutions. A typical example is the Ohio Public Employees Retirement System which had had allocations with FoFs Prisma Capital and K2 Advisors LLC. In the middle of last year the Ohio System hired specialist hedge fund consultant Cliffwater LLC to provide due diligence and manager recommendations to staff on a non-discretionary basis. The existing fund of hedge funds allocations of the Ohio System will remain in place, but from that point on new allocations to hedge funds would go to single managers with consultant input. 

The new "new thing" for state plans starting from scratch in hedge funds is to do as the State of Wisconsin Investment Board has done and go straight to single manager hedge funds without an interim phase of allocating to FoFs. The Wisconsin Investment Board has taken a decision to invest directly in 15-20 single manager hedge funds.The first allocation was to Capula GRV Fund, followed by MKP Credit Fund, Claren Road Credit Fund, Ascend Wilson Fund and BlueCrest's BlueTrend. The Employees Retirement System of Texas has announced an intention to do the same - direct investment in hedge funds, in their case a 5% allocation amounting to over a billion Dollars phased in over three years.

That is, the marginal flows to the industry are being disintermediated as far as FoFs are concerned, with consultants and advisors taking a bigger role in allocations. This has been great for the business of Albourne Partners and Cliffwater and the like, but what about the funds of hedge fund businesses? How are they getting on?

Fund of Funds In Aggregate

Each year PerTrac, the hedge fund software provider, produces an analysis of the composition and size of the single-manager hedge fund and fund of hedge fund industry. The 2011 study was produced by aggregating investment data from eleven of the world’s largest alternative databases - BarclayCTA, BarclayHedge, CogentHedge, Eurekahedge Hedge Fund, Eurekahedge Fund of Funds, HedgeFund.net, Hedge Fund Research, MondoAlternative, MorningstarHedge, Tass, and TassCTA. The combined number of investments from these eleven databases was nearly 56,000 entries. Duplicate records for single-manager hedge funds, CTAs and FoFs were removed so that a single record per fund was retained in the study to create a holistic industry list.

According to PerTrac's data,  the reported AUM of funds of hedge funds were essentially unchanged  y-o-y (+0.23%) at $447bn at the end of 2011. Given the industry had a negative return of between 5 and 8% at the single manager level last year, that implies some positive flows to FoFs in aggregate. Plus, the total number of funds of funds reporting to databases at the end of 2011 was down 4.8% on 2010 at 3,388. That is there were more assets by value overseen by fewer fund of funds managers. Someone in the fund of funds sector was doing a bit better last year!

The answer to  the question "who?" is the largest funds of funds. FoFs that reported managing in excess of $1 billion were the only group to experience a positive growth in fund numbers from 2010 to 2011 as shown in graphic 1 below.

Graphic 1. Number of FoHFs by AUM Size and Percentage Change from 2010 to 2011*

*Figure excludes515 funds in 2010 and 522 funds in 2011 that did not report AUM, source:PerTrac

Taking a look at the different size categories of funds of funds in turn, there is other evidence that  the very biggest funds of hedge funds are getting bigger. The top 10 FoF management companies (as opposed to individual funds, and as covered in the PerTrac study) added assets in 2011, according to InvestHedge data. The ten largest FoF groups managed $227bn at the end of 2011, an increase of 2.6% over the start of that year, and equivalent to 50.7% of the FoF industry's assets. In addition there were 16 FoF management companies with $10bn of AUM or more at the end of 2010. There were 17 at the end of 2011. So the very large funds of funds groups were slowly growing in aggregate.

The larger funds of hedge fund companies (those managing a billion dollars or more)  have shown stability in assets recently. The InvestHedge Billion Dollar FoF Club managed $622bn of assets between them at the end of 2011, only a tad down on end-2010 levels (-0.7%).

  

The number of FoFs containing assets of $500m-$1bn shrank last year according to the PerTrac study - there were 5.9% fewer of them by the end of 2011 than at the beginning of the year, but that size category is not where the industry squeeze is most evident. More than one-in-seven of the FOFs sized between a quarter and half a billion dollars in AUM closed down last year. It is in this size band that numbers of funds of hedge funds are shrinking most. 

This has been a long time coming - the demise of the smaller fund of hedge funds was prophesised nearly ten years ago. Very few of the mid-tier FoFs benefited from the growth of the hedge fund industry through institutional flows in the period 2003-2008. But that is not the same as saying the circumstances forced smaller FoFs out of business - they just did not grow much.  

In the period since the Credit Crunch institutional investors have completely dominated the capital inflows to the hedge fund industry. And they go big for their suppliers. HNWI investors were a major source of redemptions in the industry in 2008-9, and there have been few-to-no net flows to the industry from HNWIs in the last two years or so. It was the HNWI that was historically prepared to invest through the smaller fund of hedge fund. So in aggregate the smaller FoF experienced, say, a 35% drop in capital because of redemptions and capital losses in 2008, and little or no recovery in assets since. 

So while 47% of the funds of hedge funds managing $1bn or more experienced positive inflows last year, their smaller bretheren have seen the industry tide of capital go out and not come back again. Most modest-sized FoF managers will be running a business with the same level of income as seen in 2004-5 with the cost structure of 2012. That is not sustainable.

Reaction To Conditions - M&A

Hence the corporate activity in the fund of funds sector. For example, Nexar Capital Group was founded to pursue a roll-up strategy amongst funds of funds, and bought Allianz's fund of hedge funds business in 2010 and Caledonia Investment's Ermitage fund of funds business last year. Nexar itself agreed to be bought by UBP at the beginning of March this year. Other FoF takeovers in the last year include William Blair's acquisition of most of Guidance Capital's assets under management; Athena Capital Advisors acquired Stonehorse Capital Management; and Cantor Fitzgerald started its planned expansion into hedge funds with the acquisition of Cadogan Management. Other forms of deal seen in the last year, apart from complete takeover, have been merger and stake sale. Evercore Partners bought a large minority stake in ABS Investment Management, the $3.5 billion fund of hedge funds. The  merger between Gorelick Brothers Capital and Access Fund Management may have been defensive as the combined entity  had only $100m under management when the deal was announced.

A dealer in second-hand hedge fund assets said this week that the wind-down of some fund of hedge fund businesses has given his own business a fillip. "I see another 18 months of funds of funds mergers and acquisitions. It is great for me because it throws up holdings in companies and funds to be disposed of - there are a lot of buyers for these sorts of assets out there," he said.  "But there is a limited window for this activity, and we are in it now." What has he seen as the driver? "The funds of funds business is dying at the lower level."

 

Related articles on this site:
Hedge Fund Takeovers - Martin Currie and Schroders Acquire (June 2010)

Race for FoF Acquisitions Starts with Thames River Capital (April 2010) 

Fund of Hedge Funds Consolidation: The gun has been fired (April 2010) 

Podcast 1 - Hedge Fund M&A (Oct 2009)

Update on Reuters:
New York-based Arden has won a mandate to act as Massachusetts' so-called transition manager as the $50 billion state pension fund shifts money away from hedge funds of funds directly into a select number of hedge funds. (link, 10th May 2012)

Early View of Last Month from FRM

Fund of funds manager Financial Risk Management (FRM) produces a monthly “Early View” reviewing the hedge fund and market themes and sector performance for the previous month. 

The highlights for April 2012 were:

"We had been concerned that the hedge funds with low market beta were too slow to rebuild risk through the first three months of this year, but the reward for prudence has been apparent through April when these hedge fund managers benefited from their cautious positioning and focus on capital preservation.
 
Looking ahead, we anticipate that managers with short horizon, tactical trading styles are likely to weather thecurrent environment well. Credit and Equity Long-Short managers across regions have been finding more things to do despite the macro headwinds. We believe that the increase in dispersion will benefit these managers and allow them to build more balanced books."

Strategy summary for April 2012

Directional Trading
• Early estimates show that Systematic Trading managers ended the month in positive territory despite the intra-month volatility. The main contributor to performance was long exposure to bonds. The largest detractor for the month was long exposure to equity indices.
• Discretionary Trading managers produced a wide range of returns. Overall, managers have retained a low level of risk and have focused on short duration, tactical trading.

Equity Long-Short
• Despite the strong intra-month reversals, the average Equity Long-Short manager produced flat returns. Overall, net and gross exposures stayed at the same level though managers tended to refresh the ideas in their books. Towards the end of April managers generally covered the shorts that had worked well at the start of the month.
• The latest earnings season data has surprised on the upside in the US; some select longs in Financials were contributors in April (eg JP Morgan). US Equity Long-Short managers are increasingly focusing on domestic names over international companies in an attempt to capture the regional outperformance.
• European Equity Long-Short managers generated decent returns despite the comparatively weaker earnings data. Managers have cited the increase incorporate activity and company-specific news as the main drivers. 

Specialist Credit
• The early estimate data suggests that Specialist Credit managers are likely to end the month with flat to positive returns. Refinancing events are expected to be a positive contributor in April. Bearish managers with short exposure to European sovereigns and financials are also likely to have had a strong month.
• US credit markets appear to be showing signs of de-correlating from Europe. This is a positive for managers as it allows them to benefit more from company-specific drivers rather than macro factors. An example of this is US new issuance which has continued to be robust despite the increased concern over European sovereigns.

Relative Value
• Relative Value managers posted mixed returns in April. Event Arbitrage managers struggled to add value as deal activity continued to be muted. Those involved in special situation deals also tended to suffer mark-to-market losses.
• Performance was flat in aggregate for Convertible Bond Arbitrage managers. Valuations came under pressure as outright investors became net sellers for the month. The increase in volatility, however, was positive for gamma trading.
• Statistical Arbitrage managers also ended the month flat. Early estimates indicate that, technically-oriented models (eg Momentum) tended to outperform fundamentally-oriented models (eg Value). Some managers reduced the allocation to their value-driven models during the month in line with their risk management
strategy. 

Man Group Quarterly Figures – Still Minor Outflows

Man Group Plc announced first quarter 2012 figures today.

31 March 2012 FUM of $59.0bn which represents a 1.0% increase quarter on quarter:

• 31 Dec 2011 AUM: $58.4bn (as previously reported)
• Net outflows: $1.0bn
• Investment movement: $2.0bn
• FX & other: -$0.4bn 

31 March 2012 FUM by product line:

• Guaranteed: $9.1bn
• Open-ended alternative: $25.0bn
• Institutional FOF: $12.4bn
• Long only: $12.5bn

There was a net outflow from alternative funds of $1.4 billion and a net inflow of $0.4 billion into long only styles.

Sales of open-ended alternatives were $1.7 billion and redemptions were $2.6 billion. Within this category, AHL had net outflows of $0.7 billion, driven mainly by continuing redemptions from Nomura Global Trend. GLG Alternatives recorded a small net outflow of $0.2 billion, with strong flows into the European long/short style offset by small outflows across a range of other strategies.

 

Performance fees: three-quarters of performance fee eligible GLG FUM at or within 5% of high water mark at end March. Man AHL 14% from peak on a weighted average basis.

Balance sheet: net cash of approximately $250m (down from $573m at 31 Dec). Surplus regulatory capital unchanged at $550m.

Outlook: reduced redemptions but sentiment remains fragile. Yet to see an increase in sales. More de-gearing anticipated - $0.4bn on 1 April and $0.6 on 1 May.

Valuation: Man trades at 5.8x 2012E EBITDA and at 9.8x 2012E adjusted diluted EPS.

Hedge Fund Industry Assets Recover to Last Summer’s High

Highlights from HFR Global Hedge Fund Industry Report 1Q 2012

• Total capital invested in the global hedge fund industry increased to $2.13 trillion, surpassing the previous record of $2.04 trillion set at mid-year 2011.

• Investor preferences for fixed income-based Relative Value and less correlated Macro strategies, which have been favoured for over two years, accelerated in 1Q12, with these two strategies receiving an overwhelming majority of the new investor capital for the quarter. Investors allocated $12.4 billion in net new capital to Relative Value and $7.8 billion to Macro, while redeeming $2.9 billion from Equity Hedge and $940 million from Event Driven strategies.

• Investor preference for the industry’s most established managers continued to be pronounced in 1Q12, with $18.3 billion in new capital allocated to firms with greater than $5 billion in AUM, while firms managing less than $5 billion experienced a combined net outflow of nearly $2 billion for the quarter. 

• Investors continued to reduce exposure to hedge funds via Funds of Hedge Funds, with FOFs experiencing a net outflow of $5 billion in 1Q, representing the 4th consecutive quarter in which FOFs experienced a net outflow. While only 13 percent of FOFs experienced net asset inflows during the quarter, as a result of performance gains, assets invested in FOFs increased by $14 billion to end 1Q12 at $644 billion.

Hedge Fund Radio on the 2nd April

Make sure you listen out for the Monday, April 2nd edition of the three time Sony Awards-nominated N@ked Short Club on Resonance FM [104.4FM within London/online worldwide on the internet here]: 1 hour of loose talk about hedge funds and the state of the world, plus sweet poetry and heady music...No promotional agenda, no commercial intent...just Ponzi Bier and Pure Alpha both on tap.

Host, Dr. Stu will help callers to the Emergency Hedge Fund Helpline (1-800-DISTRESSED) to re-attain their Inner High Water Mark, with expert guests: Matthew Roberts- Head of Multistrategy Hedge Funds, Towers Watson; Simon Kerr- Founder, Enhance Consulting/the Simon Kerr Blog; Stephen Pope- CEO, Spotlight; Andrew Kinsey-Quick- Head of Hedge Fund Research, Kleinwort Benson; Marc Ostwald- Strategist, Monument &amp - Sarah Dudney Writer & CEO, Ignite. Feedback to doctorstu@resonancefm.com

The show is broadcast between 9-10pm/ 21.00-22.00 hrs., London time.

Hedge Fund Radio on the 30th January

Hedge Fund Radio on the 30th January 2012

Make sure you listen out for the Monday, January 30th edition of the twice Sony Awards-nominated N@ked Short Club on Resonance FM [104.4FM within London/online worldwide on the internet here]: 1 hour of loose talk about hedge funds and the state of the world, plus sweet poetry and heady music...No promotional agenda, no commercial intent...just Ponzi Bier and Pure Alpha both on tap.

Host, Dr. Stu will help callers to the Emergency Hedge Fund Helpline (1-800-DISTRESSED) to re-evaluate their Inner Mark to Market, with expert guests: Dr. Peter West- PAM Global; Adam Sorab- CQS; Richard Watkins- Liability Solutions; James Parker- Aravis; Simon Kerr- Enhance Consulting/the Simon Kerr Blog;  Sam Jones- The Financial Times; Amelia Colvin- Gerson Lehrman; plus by Tantric Videolink from the US, Mike Gasior- AFS.

The show is broadcast between 9-10pm/ 21.00-22.00 hrs., London time.

Millennium Capital Leads the Large US Managers in Europe

One of the consequences of the Credit Crunch of 2008/9 was a scaling back by hedge fund managers – they cut their gross, they restricted redemptions, and, in managing their companies through a traumatic period for the industry, the larger managers often reduced headcount or closed their offices in Asia and London. When there were strategic cost saving measures made post-2008 it was more likely that the Asian outpost of a US hedge fund group would be scaled back rather than the London office. Often there was a pause in hiring in Europe – as seen in the time-series of the number of Approved Persons* registered with the UK’s FSA for Davidson Kempner European Partners and Moore Europe, graphics 1 and 2 below.

Graphic one: Headcount of Approved Persons (Staff Registered with the Regulator) at Davidson Kempner European Partners in London Since 2004

Source: Financial Services Authority Register/IMAS

Graphic two: Headcount of Approved Persons at Moore Europe Capital Management since 2004

Source: Financial Services Authority Register/IMAS

Less typical in management of headcount of the US firms with London offices was Steve Cohen’s SAC, which had operated in London since the turn of the century through Walter Capital Management. SAC scaled back the investment, compliance and senior management staff in its London operations (renamed S.A.C. Global Investors) by about a third in 2008/9, as graphic 3 below shows. As events unfolded and financial markets returned to something more like normal in the years after the Credit Crunch, SAC increased its headcount in London, just as it did in its Connecticut headquarters. The expansion phase post-Credit Crunch at SAC in London included the re-hiring of some traders let go less than a year previously.

Graphic three: Headcount of Approved Persons at SAC Global Investors in London Since 2004

Source: Financial Services Authority Register/IMAS

Staff numbers at SAC in Europe have continued to be managed on a flexible basis, in that the Euro shock of May/June 2011 coincided with the peak in professional staff, and a net 8 traders and other professionals (those that have be registered with the FSA) have left since. It could be said that SAC has been particularly proactive in managing its head count to short term business conditions compared to most US managers with London offices.

Graphic 4 is a table showing the American hedge fund firms with the 20 largest staff teams in London.  Only four firms (Moore Capital, Millennium, Citadel and Tudor) have 40 or more traders and portfolio managers based in Europe’s financial hub. Only 13 US-controlled hedge fund firms have professional staffs of 20 or more, as reflected in Approved Persons registered at the FSA. And by inference, less than 20 American hedge fund firms have total staff numbers of 30 or more.

Graphic Four: 

The 20 US Controlled Hedge Fund Groups With the Largest London Headcount At The End of 2011

Source: Financial Services Authority Register

Looking at just the 30 American-owned hedge fund firms with the largest London offices, Table 5 ranks the firms with the largest increase in headcount over the last year. Across all 30 of the funds analysed in detail professional staff numbers went up by a modest 6% in 2011. This is only a few dozen staff across all the firms covered, and a third of the surveyed firms showed exactly the same (professional)  headcount at the end of the year as they did at the beginning. So the overview is one of stability in market-focused human resources for the European outposts of these firms, with some modest expansion at a minority of hedge fund management companies.

Izzy Englander’s Millennium Capital Partners is the standout. The firm has been in expansion mode on the back of good results – its Millennium International Fund was up over 8% last year. It turned out to be good timing for the firm to hire its first head of marketing, John Novogratz, in the first half of last year, and he had some early wins as firm-wide assets went from $9.2 billion to $11.6 billion in 2011. The increase in AUM over 2011 has given scope to add to capacity in Europe, and Millennium has added 22 FSA registered staff members including traders.

Graphic Five: Ranking of Change in Headcount Amongst UK Staff of American-Controlled Hedge Funds

 Source: Financial Services Authority Register

The absolute numbers of staff added are not large for most of the firms in Table 4 and 5, and so there is some reluctance to draw inferences for most of the firms cited. That written, firms that trade as much as invest for a living are a feature of the ranking of firms in expansion mode – SAC, Tudor, Soros Fund Management to an extent, and Millennium.

On the other side of the coin, Table 6 shows the American hedge fund groups that that shrank their professional staffs over the last year.

Graphic Six: 

Ranking of Change in Headcount Amongst UK Staff of American-Controlled Hedge Funds - Declines

Source: Financial Services Authority Register

Again the changes in numbers are small in absolute terms, so frictional turnover may account for the changes in staffing in Table 6 and the shrinkage may not necessarily be through management decision making. The only generalisation drawn is that event driven managers are a feature of the list, and give what has happened to markets in 2011, a large reduction in public market transactions makes resource re-balancing in that strategy understandable.

American Management Compared to European Management

Finally, there is a comparison available for how the top American hedge fund managers manage their London-based offices compared to the top European hedge funds. In November an analysis of the staff registered with the FSA for hedge fund groups indigenous to London was carried out here.   The analysis of Europe’s top managers covered the changes in human resources over the year to the end of August 2011. By one of those strange coincidences, the top managers in London in aggregate had added 6% additional professional investment staff over that period of 12 months, the same percentage as the top 30 US-controlled firms have added over the last year.

Employment is a lagging indicator in macroeconomics, and the hedge fund industry is no different in that business conditions have to be stable for some time before managements assume the risk of adding to their cost structure for staff. Provided that December redemptions are at the level indicated by the industry scuttlebutt (GlobeOp data and the like) it can be assumed that we will see a steady if unspectacular increase in hedge fund employment in London in the first half of 2012.  

* Approved Persons are those registered with the Financial Services Authority to carry out regulated activities – all partners in a partnership and those carrying out specific duties, such as CFO, CEO, senior operations staff, compliance officers, and traders and portfolio managers.  Staff not registered at the FSA can nearly equal in number those registered with the UK’s financial regulator where firms have local middle and back office operations, a marketing presence in Europe and/or risk management and technology staff.

Hedge Fund Returns Are Path Dependent - As 2011 Illustrates

One of the things that is attempted on this website is to look at market action to help explain, or comprehend hedge fund returns. For example, two years ago a commentary was distributed on the significance of the quality factor in explaining returns in 2009 (see this article), and the impact of high correlation this year was explored  (here) too. This year has been a very unusual year in the macro background and in how markets have moved - year three of a recovery does not normally look like this one in economics or markets. 

The market events of this year have been a slalom course for hedge fund managers to negotiate (risk on/risk off), and the hedge fund indices reflect that. The HFRX Global Hedge Fund Index was down 8.58% for the year up to Monday (the 5th of December), and directional funds have fared a lot worse than non-directional strategies (the former are down 18% on an index basis).

Manager letters can be a good source of market context for hedge fund returns. In particular managers taking a quantitative approach are risk aware by nature and typically have a numerically stronger way of expressing the market conditions, and the suitability of their own methodology for extracting value from them.The overview reproduced below comes from Quant Asset Management of Singapore, managers of a portfolio of global equities.

Dear Investor,

It is unusual for us to add any written text to our monthly email other than the standard text in the newsletter. Since we apply a consistent, systematic investment methodology, once familiar with the methodology, the newsletter is normally self-explanatory. But because we are currently witnessing the biggest draw-down since the inception of the QAM Global Equities fund, 71/2 years ago, we’d like to use this opportunity to share some of our thoughts on this.

We now had a period of seven consecutive negative months with the fund being down 22% for the year. The main reasons for the negative performance are:

1) We use mostly fundamental factors when selecting our stocks from a global universe of over 6000 stocks. Fundamentals haven’t been driving markets in the past seven months. Macro-economic factors were driving markets and correlations have been at an all time high.

2) We use a trend following methodology that adjust factor weightings each period for what worked well in a certain past period (dynamic) before. This didn’t work well in the past seven months due to volatility spikes and trend reversals.

3) We use a hedging methodology whereby we are either 0% or 50% net exposed mostly based on aggregate earnings revisions number and some price performance related techniques. This hasn’t added value in the past seven months.

So the question arises if our methodology is still valid and when will it work again?          

First of all; all good investment methodologies go through periods where they struggle but as long as they add value over time and make logical sense, it makes sense to stick with them in order to achieve above average returns.

Furthermore we believe that systematically picking a large number of stocks on the basis of fundamentals (valuations, earnings growth and earnings revisions) combined with a factor adaption methodology, whilst hedging out a large part of the market risk, does add lots of value. Remember that the fund is up 154% since inception. This compares to 16% for the MSCI World in the same period.

We have always allowed volatility in our funds (around 20%, which is much more than most of our peers) in order to achieve higher returns than our peers. These high returns have been achieved and we have a strong belief that they can be achieved again. In order for this to happen one has to allow certain periods of under-performance. Draw downs are pretty natural and frequent in fundamental factor adaptation systems and one should be reminded that they can create opportunities too.

Kind regards,
The QAM Team

The letter is reproduced here to give some insight to market drivers of return this year, not to point fingers at a style or a particular manager. The general point is that the vast majority of managers take a specific approach to markets that they hope works most of the time and for most market conditions. The marketing conceit of an "all weather" hedge fund or strategy died in 2008. The returns delivered by a manager are a function of their own style and the opportunity set available from the market over the period. It is very striking  that the gyrations of markets in 2010 and 2011 made it very difficult for equity hedge fund managers to make positive absolute returns except when the equity market letter was written by the Fed and other central banks through the mechanism of QE2 (from August 2010 to March 2011). 

Hedge fund returns are path dependent, not independent of the direction of markets, nor independent of changes to intra-market or inter-market correlation, nor unaffected by the extent to which markets trend. The specific sequence of ups and downs, step-wise shifts in volatility, and how long a market regime lasts impacts the ability of the manager to harvest alpha in the way they are set up to address markets. So, for example, it would not just be relevant that markets were down 5% over a six month period, but in understanding outcomes it is more relevant that they appreciated by 11% over six weeks before losing 15-16% over 4 months (with specific volatility and correlation conditions). 

It is up to the investor in hedge funds to put together portfolios of funds which take account of the various market conditions which may occur, in full knowledge of the manager style. Building such an efficient portfolio of funds can only be achieved when investors truly understand how their capital is being applied to markets by their managers. Provided the managers stick to their expressed style, there should be a limited number of surprises to investors in hedge funds given market conditions, and how market conditions change (the specific path markets follow). For any given market conditions and sequences the better investors in hedge funds will have a range of expected return per manager in which they are invested. As yet, the path dependency of hedge fund returns is not sufficiently well appreciated  - spread the word.



UCITS III Footnote - the offshore fund from QAM was down 23.49% over the period end Feb 2011 to the end of November. The onshore equivalent  - Quant Global Equities fund, a sub-fund of the Quant AM SICAV (a UCITS III type fund) - was down  27.77% over the same period. The onshore version launched in March this year.