Despite hedge fund assets being at an all-time high and predictions of strong performance from most managers, many believe 2013 will be another challenging year for the industry, according to Rothstein Kass’s annual hedge fund outlook report.
Produced by the Rothstein Kass Institute – the firm’s thought leadership arm’ – Water Water Everywhere’, a survey of 358 hedge funds, reveals that those sentiments are based largely on unbalanced capital inflows that have plagued the industry since 2009.
“Asset flows have emerged as an important theme in each of our studies since 2009, but the issue has clearly taken on a new level of significance based on what we heard this year.” says Howard Altman, Co-CEO and Co-Managing Principal of Rothstein Kass. “The hedge fund industry has continued to see increased asset flows in recent years, including 2012, but capital flows have been concentrated largely into funds with more than USD1 billion under management, which represent the lion’s share of assets, but a relatively small number of funds. As a result, many of the managers we speak with feel like the Ancient Mariner, with business critical assets in the place of life sustaining water.”
Even though the majority of managers polled (55 per cent) predict better performance in 2013 versus 2012, nearly half of those polled (42 per cent) believe 2013 will be a difficult or somewhat difficult year for the hedge fund industry. Roughly half of those polled (49 per cent) identified asset raising and marketing as their biggest concern heading into 2013. Fully two-thirds of respondents (66 per cent) believe that consolidation will intensify in 2013, with marketing and asset raising identified by 44 per cent of those polled as the leading catalyst for consolidation, followed by regulatory developments and/or compliance costs (32 per cent).
“Certainly consolidation must appear to be an increasingly viable solution for smaller funds as barriers to entry and the costs of doing business have increased for hedge funds across the AUM spectrum,” says Altman. “Investors continue to demand more transparency, intensive due diligence, separately managed accounts, as well as more robust operational infrastructure and controls. The costs associated with SEC registration and Form PF are not insubstantial either, especially when consulting, IT, and employee time are factored in. At the end of the day, there is just no denying that successful asset raising is crucial to success as the most effective way for hedge funds to quickly build economies of scale.”
Approximately three-quarters of those polled anticipate that institutional investors will continue to prefer allocating to larger managers, while another 49 per cent of those polled agreed or strongly agreed that emerging manager would see increased allocations this year.
The survey also revealed that an increasing number of funds would seek seed and acceleration capital in 2013 as a way to address capital raising shortfalls. In 2012, 6.5 per cent of those polled sought and received seed capital, while 4.5 per cent collected acceleration capital and another 11.5 per cent sought these types of capital but did not receive it. In 2013, nearly one-third of those polled will be pursuing seed or acceleration deals.
“We see a tremendous number of hedge funds on the seeding trail at this point,” says Meredith Jones, a director at Rothstein Kass. “Unfortunately, at the present time, we don’t see any way that the demand for seed and acceleration capital can entirely be met. We presently track between 60 and 80 active professional seeding and acceleration firms, each of whom complete between zero and three deals per year, on average. Certainly, there are more entrants into the seeding/acceleration field almost daily, but until the supply of seeders matures, some of those seeking these rapid capital infusions will be disappointed. Slow and steady capital acquisition may have to suffice for a large number of managers.”
Despite a challenging fundraising environment, nearly two-thirds of those polled (64 per cent) plan to increase capital by more than 25 per cent in 2013. Young funds are the most likely to be on the fundraising trail as nearly 90 per cent of those funds polled indicate that they will attempt to grow assets by 25 per cent or more this year. The survey also reveals that the capital raising cycle has lengthened, with nearly three quarters of those polled (73 per cent) indicating their capital raising cycle takes 6 months or longer. Women-owned or –managed funds reported the longest fund-raising cycles, with half of those polled indicating it takes more than a year to secure an investment.
Other notable findings include:
- Nearly a third of those polled (32 per cent) predict that long/short equity will be the best performing strategy for 2013.
- Women-owned or managed funds were amongst the most conservative when it came to performance predictions for 2013, with none anticipating returns of 20 per cent or greater. This is despite ending 2012 strongly, posting a roughly 11.0 per cent net return, outperforming the overall hedge fund indices.
- Nearly half of those polled (49 per cent) will use the same amount of leverage in 2013 as they did in 2012.
- Women-owned or managed funds were also the most conservative when it came to leverage. Roughly one-third of those polled plan to use no leverage in 2013.
- More than a tenth of those polled (13.0 per cent) plan to add due diligence days in 2013 and nearly 20 per cent of the hedge fund respondents are considering launching them.
- Family offices and high-net-worth individuals were identified as the most important sources of hedge fund capital (39 and 34 per cent respectively) followed by pensions (20 per cent). Larger funds and diversity funds were more likely to cite institutional investors as the most important source of capital.