By Lydia Tomkiw
The hedge fund industry is set to see liquidations outpace launches in 2016 at a rate not seen since the financial crisis of 2007-2009. And for the much smaller pool of firms that launched in 2016, amid a year of grim headlines about redemptions and outflows, finding the right alignment of interests with investors and setting up shop in strategic ways will be key to surviving and thriving in 2017.
The upshot of all the turmoil is that managers have seen the ground shifting beneath them.
“The volume of launches globally has greatly declined. Capital raising in this environment remains very difficult,” says Gary Berger, a partner heading the emerging manager platform in the alternatives practice at KPMG. “Managers are realizing investors are not going to pay a high fixed fee unless there is a reason to do so. We are seeing the managers adapting to that.”
Hedge fund launches were far off pace in 2016. Launches fell in the third quarter of 2016 down to 170, with the period marking the lowest number of firms opening since the first quarter of 2009, when only 148 hedge funds launched, according to the most recent data from Hedge Fund Research. The third quarter of 2016 marked the fourth consecutive quarter of liquidations outpacing launches, and 782 firms had closed through the third quarter of 2016 compared with 576 launches.
The launch pace also was off significantly from 2015, when 785 funds had started up by the third quarter.
Meanwhile, the rising tide of closures included some big names. Perry Capital and Chesapeake Partners both announced 2016 closures, as did newer firm Ardmore Global Investors, as Reuters reported. Last year also saw private equity heavyweights Carlyle Group exit the hedge fund business, while Blackstone Group closed its hedge fund arm Senfina Advisors, as previously reported.
Despite the closures, overall hedge fund industry assets have increased to total over $3 trillion in assets under management, driven in part by market gains, as previously reported.
And as hedge fund managers bid farewell to the difficult capital raising environment of 2016, the post-election market bump and the potential for ongoing volatility could make for a much better 2017.
“Investors have largely been on pause, but the environment feels like it has been thawing since November,” said David Frank, CEO and managing partner of hedge fund marketer Stonehaven, in an e-mail. “We are expecting a very robust first quarter.”
For firms that did launch in 2016, having a portfolio manager with a pedigree, a solid performance record, and an attractive fee structure were critical to drawing investor attention amid debates over hedge fund allocations, Berger says.
Mill Hill Capital was among the 576 launches through the end of the third quarter. The New York-based firm, led by David Meneret, formerly the head of securitized debt trading at Macquarie, focuses on market-neutral credit relative value investments across U.S. corporate and securitized credit markets. Mill Hill started trading in November after securing a seeding deal with Protégé Partners. Mill Hill would not reveal the size of the seeding deal, but other recent deals have started at $50 million.
The firm of six people says it expects to have over $100 million in assets under management in the early months of 2017.
“I’m not going to lie – it’s hard to raise money in the hedge fund world. It’s harder than before and it’s hard to get a seed deal,” Meneret, who is the CIO, says. “There’s a lot of competition.”
With the last great year of capital raising for hedge funds occurring in 2006, the competition has increasingly pushed funds to launch with founders’ classes as well as other arrangements, such as lock-ups and fee discounts, says Frank Napolitani, director on the financial services team at EisnerAmper.
“There’s a saying that the biggest concerns, one through nine, are capital raising. Number ten is everything else,” he says.
For Meneret, that meant having all the partners invested in the fund and offering investors a founders’ class with a more attractive fee structure. He declines to outline the exact terms of the fee structures.
Symphonic Alternative Investments, an Arlington, Va., based fund focused on emerging markets, launched early in 2016 with a founders class structure as well. It has two funds trading $5 million each of internal seed capital.
“We believed the time was right to move out on our own and begin investing in the space,” says co-founder and CEO Brian Walker.
Walker, along with co-founder and CIO Peter Trofimenko, wanted to establish a three-month track record before moving forward and marketing their funds. They have chosen to come out with a discounted founders’ class with a 1.25% management fee and a 15% performance fee, as well as another post-founder’s class.
“Building a business from scratch under any circumstances is challenging,” says Trofimenko. “[With] seeding, we consciously did it that way because we want to demonstrate to prospective investors that our skin is in the game… We put our money where our words are.”
For funds launching with less than $250 million in assets under management, outsourcing functions not tied to investment strategies has become important to ensure shops get off the ground, Napolitani says.
“Today you can outsource in a much more efficient, cost-effective, productive manner,”Trofimenko says. His firm has chosen to outsource various services, including information technology and legal.
Mill Hill also chose to use a third party IT provider, as well as a third party compliance solution that works closely with their in-house CCO.
“In terms of risk management and portfolio management that’s a key element of what we do, and we do that in-house,” Meneret says.
For managers that did take the plunge in 2016, launching amid tough conditions could help them differentiate themselves in a competitive and crowded marketplace.
“It’s pretty much like everything – when an industry is not very much loved, it’s often the time to get into it,” Meneret says. “It doesn’t always work, but hedge funds have been there for a long time and I don’t think they are disappearing.”