The capital-raising outlook for emerging hedge fund managers is – perhaps unsurprisingly – mixed. First, the bad news. With hedge funds’ performance suffering in recent months, the fundraising environment is back to where it was before the pandemic: investors are taking fewer risks, strengthening their thresholds for investment, and pulling money from hedge fund products on a net basis.
The capital-raising outlook for emerging hedge fund managers is – perhaps unsurprisingly – mixed. First, the bad news. With hedge funds’ performance suffering in recent months, the fundraising environment is back to where it was before the pandemic: investors are taking fewer risks, strengthening their thresholds for investment, and pulling money from hedge fund products on a net basis.
Yes, rising interest rates and roiling equity markets have led many allocators to temper their excitement for private markets with a shift away from fixed income replacements and towards alternative investment products with greater liquidity. But the myriad other macro and microeconomic forces at play have created a complex picture – and that complexity has stifled what was starting to become, at points last year, a widening opportunity set for smaller funds.
One third of emerging hedge fund managers (AuM <$250m and track record <5 years) surveyed by Hedgeweek in Q3 2022 described investor interest in their strategy as ‘strong’ 12 months ago; among the same group, only 26% described investor interest as ‘strong’ today. Most emerging managers surveyed described investor interest in their strategy today as ‘moderate’.
Reasons for optimism
Now, the better news. Although the opportunity set for emerging managers has not widened, there are signs that it has deepened. The current market environment may not favour emerging managers per se, but it is helping hedge funds create compelling narratives around navigating volatility and downside protection, and there are still plenty of investors actively seeking these stories.
According to the preliminary results of a new Hedgeweek investor survey, around one quarter of alternative investment investors are planning to increase their allocation to hedge funds over the next 12 months, with less than 15% planning to decrease their allocation.
More significantly, over half of allocators surveyed were either investing in emerging managers already or were considering investing. That interest continues to come primarily from family offices, private wealth investors, and funds of funds: around three in five investors across these groups invest in emerging hedge funds. Among those that don’t, one in three are considering it. Larger allocators – pensions, insurers – remain unlikely to invest or consider investing in emerging managers (the full results of Hedgweek’s investor survey will be published in December).
Much still depends on investment strategy. During research interviews, Hedgeweek heard of returning – or sustained – investor interest in emerging managers running credit long/short and equity market neutral strategies, and multi-strategy products.
“The current environment is better than this time last year – we are seeing investors who we contacted over the last 18 months returning to have serious allocation conversations. I think this change is attributable to investors acknowledging an increase in macroeconomic uncertainty and overall market volatility. Our strategy resonates well with investors in this environment,” says John Caruso, managing member of A.Line Capital Partners, a US equity and derivative centric multi-manager hedge fund implementing a first loss investment strategy. A.Line is seeing interest from consultants on behalf of family offices and endowments, fee-based RIA firms and seeding hedge funds.
Macro interest
Investor interest in global macro has generated headlines in recent months and the initial results of Hedgeweek’s allocator survey supports suggestions it will be among investors’ favoured strategies in 2023. Macro launches have long been stifled by particularly high barriers to entry and tier one macro brands hoovering up flows. Recent reports had Brevan Howard reopening its $10 billion flagship to new investors following returns of around 20% YTD through September. In a further indication of pent-up demand, the London-based macro specialist is introducing
new ‘pass through’ fees as part of move.
But someone in the macro subset is losing out – mostly other large and midsized firms. Recent data from eVestment suggests macro hedge funds generally saw net outflows in September close to $5 billion, part of an industry outflow of $21 billion, despite the strategy being among the industry’s better performers YTD. Hedge Fund Research’s HFRI Macro Index has returned 11.5% YTD through October, compared to a -4.5% decline at the HFRI Fund Weighted Composite Index.
Of course, top-level industry data can paint a misleading picture of interest in emerging managers, especially when consumed alongside high-profile media reports of hedge fund redemptions. Smaller manager sentiment from Hedgeweek’s research interviews could be characterised as pragmatic, with many reporting positive conversations and some successful allocations, albeit mostly through traditional channels. The caveat: winning new business requires more time and resources.
Patience and perseverance
“The fundraising channels for smaller managers are largely the same, but the process is taking longer,” says Steven Greenblatt, head of institutional sales at NightShares, an emerging US-based ETF and fund manager. Greenblatt – who has been a hedge fund fundraiser for nearly 20 years, including roles at First Quadrant and FrontPoint Partners, and more recently smaller long volatility/options shop Logica Capital – draws a distinction between ‘celebrity’ start-ups and regular start-ups. At the latter, he says, marketing professionals should expect relationships to take a year or more to yield investment.
But those relationships are forming, especially at managers running timely investment strategies. Jonathan Bowers, CIO of London-based emerging alternative credit manager Acer Tree, says, “investor appetite has shifted in the last few months”, in response to macroeconomic forces, reversing flows into fixed income/yield products and leading to increased demand for credit long/short strategies.
“We expect this trend to remain intact for several years and provide an important capital re-allocation opportunity for investors, in particular pension funds,” Bowers explains. “We also expect manager performance to be highly skewed led by experienced teams in fundamental long/short strategies with a proven track record of delivering positive returns in volatile and bear markets.”
More recently, Acer Tree has shifted to raising additional funds for its flagship credit opportunities hedge fund. There are opportunities for certain credit managers “unseen since the GFC”, and Bowers feels the team’s long/short fundamental strategy is well placed to capture them. In the past six months, Acer Tree’s credit opportunities fund has prompted interest from investors in North America, Europe, and the Middle East.
As well as its hedge fund, Acer Tree runs a CLO business that has received “phenomenal support” from investors in the past 18 months, allowing the team to place 95% of the equity on its first deal. “We are seeing promising signs of a market pick-up for 2023,” Bowers adds.
Key takeaway | For managers | The increased volatility this year and resultant downturn in industry performance has stifled, what was last year, growing interest in emerging managers from new investor types. Still, there remains opportunities with familiar investor groups, even if allocations are taking longer to win.
