Hedge fund allocators are increasingly worried about the risks of crowding, according to a new Bank of America survey, however, these same investors are consolidating their portfolios into a few large multi-manager firms, exacerbating the potential problem.
The survey, which polled 160 allocators managing around $680bn across 4,300 hedge funds globally, found that the largest hedge fund managers continue to attract the bulk of the industry’s assets despite concerns about rising costs. Investors are shifting toward fewer funds in their portfolios, moving away from diversification.
“Respondents have generally moved towards fund consolidation rather than diversification within their hedge fund portfolios,” the report noted. Allocators are following a “one in, two out” strategy, where a new allocation to a fund often coincides with the full redemption of two others.
As a result, the industry’s largest players are getting even bigger. In the first half of 2024, $7bn in net inflows were spread across the $4.3tn hedge fund industry, with multi-manager funds like Millennium and Citadel leading the way. Multi-strategy funds attracted $10bn in net flows during this period, and the average multi-manager firm now manages about $1.7bn, compared to $528m for the average hedge fund overall.
About 50% of survey respondents identified crowding as their top worry as they close out 2024 with multi-manager funds, having been criticised for moving in tandem during volatile periods.
Allocators, though, are now gaining more leverage in negotiations with these large firms, especially as some struggle to outperform the risk-free rate in a higher interest rate environment. According to Bank of America, 42% of respondents reported that fee hurdles were becoming more common for at least one of the funds in their portfolio, with the survey highlighting that this shift marks a “buyers’ market,” where managers and allocators are better aligned.