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Comment: There are opportunities beyond capacity constraints

Forsyth Partners remains bullish about future opportunities, despite widespread concerns over increasing capacity constraints in the hedge fund industry.

The company's view is that capacity pressures evolve, and that strategies that look stretched today could be the opportunities of the future. Indeed, the real capacity issue facing the hedge fund industry is whether investors can access the managers they want to.

"The hedge fund industry is now estimated to hold USD 1 trillion in unleveraged assets, and with such continued interest, one could easily believe that there are too many managers chasing too few ideas," explains Forsyth's Head of Alternatives Investments, Tracy Pearson. "But pressures on capacity change over time.

"For example, at the strategy level, look at M&A where up until recently opportunities were thin on the ground, forcing an outflow of talent from the industry and a reduction in funds targeting this sector. The markets have moved to a different stage of the business cycle, opportunities have increased and the situation has turned around. Thus, capacity for M&A managers has been revised aggressively higher, especially in European mandates."

Pearson also highlights the case of smaller managers. "We continually see smaller managers with limited resources successfully dealing with additional capacity. Experienced team expansion opens up new opportunities over time and increases capacity.

"We see the real issue of capacity facing the industry as being the ability for investors invest with the managers they want. We want our managers to outperform, so we listen closely to their calls on capacity and prefer to focus on managers who are comfortable with their assets under management (AUM).

"Managers who change their capacity constraints during the tenure of the fund without an obvious change in strategic opportunities always ring alarm bells as we often find that such asset-gathering can detract from returns in the long term.

"We also consider that not all assets are equal. Managers who are smart in controlling their AUM tend to prefer sophisticated investors who understand the investment strategy -- an appreciation of the manager is crucial to gaining capacity."

Forsyth Partners runs a series of highly diversified fund of hedge fund (FOHF) portfolios, with assets in excess of USD 1 billion. "FOHFs have been criticised for not being able to access many of the better known hedge funds, which are often closed to new investors," says Pearson. "But this is simply not true. Capacity gets freed up in these big names and gets offered to FOHF managers even if the funds are seemingly closed.

"Even so, we don't lose sleep over accessing these big names, as we firmly believe that the best returns are achieved during the first 18 months of a hedge fund, when the manager is smaller, more nimble and focused.

"Forsyth's highly diversified approach means we are less susceptible to capacity constraints than our more concentrated peers," adds Pearson, who points to a number of methods of avoiding capacity problems.

"Firstly, with key managers we work hard to negotiate guaranteed capacity going forward. Secondly, we look further afield than many and have found a number of interesting new managers in Asia, Canada, Australia and the emerging markets. By allocating realistically sized investment positions in smaller managers (i.e., sub USD 250m AUM) we avoid the risks of large client bias and redemption concerns. We also tend to allocate assets incrementally rather than trying to force money onto a limited number of managers.

"There has been a spate of launches into the long/short equity area which does raise the question of capacity. But our dedicated research helps us identify niche funds off the radar of many managers," she concludes. "Although these funds do indeed face constraints, this can be eased by getting in early."

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