FoHFs – shrinking without trace?

Funds of hedge funds are struggling to attract investment more than the funds they invest in

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Funds of hedge funds (FoHFs) account for 28.25% of the hedge fund industry's asset base (figure 2) compared with year-end 2008 assets under management (AUM) of about half all hedge fund assets. Since then, the ratio of FoHF AUM to hedge fund AUM has risen in only one quarter – Q3 2014. Cumulatively, the fund of hedge funds industry has experienced net investor redemptions of -$382.67 billion since the end of 2008.

evestment1-hfr0916Total FoHF assets under management stood at $841.57 billion at the end of Q1 2016. Over the past four quarters, net investor flows were -$50.29 billion and asset change due to performance was -$51.53 billion. Multi-strategy FoHF AUM, a subset of the wider industry figure, stood at $653.3 billion at the end of Q1 and represented -$43.88 billion of net outflows from the industry.

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evestment3-hfr0916Figure 4 illustrates the evolution of FoHF fees over the past 15 years. We show average headline fees for FoHFs with inception dates during or prior to the year in question and actively investing through that same year. On average, FoHF management fees have fallen by approximately 6 basis points (bps) and incentive fees increased by 89bps over the past 15 years. However, since year-end 2009, we have seen a declining trend in management fees. A similar trend for incentive fees is clear since 2011. Our analysis excludes any additional fee disclosures such as custodial and administrative costs that may be assessed by firms annually.

evestment4-hfr0916The weighted average AUM of underlying funds increased 15.50% annually on an average basis and 32.26% on a median basis over the past 18 quarters (see figure 5). In contrast, total hedge fund industry asset grew 4.65% over the same period. There is also a decreasing differential between sample average and median of weighted underlying fund size since 2012–13 levels, suggesting widespread convergence in the attitude of FoHFs toward appropriate portfolio fund size and/or capacity constraints since 2011.

evestment5-hfr0916Figure 6 contains two sample averages – the average of weighted underlying fund size and the average of median underlying fund size. The majority of FoHFs that report one of these statistics also reports the other. Currently median portfolio fund size is approximately $1.29 billion, retracing from a peak of $1.65 billion in Q4 2014 to Q4 2013 levels – and for a compound annual growth rate (CAGR) of 12.44% since Q4 2011. The weighted average has similarly seen a trend downward in recent quarters, but has risen dramatically over the past 18 quarters on a dollar basis, currently sitting at $2.91 billion at the end of Q1. The number of portfolio funds across our sample has declined fairly consistently since the end of 2011. Average annual manager turnover has rebounded to pre-2014 levels to approximately one-fifth of the portfolio.

evestment6-hfr0916Our FoHF portfolio fund data clearly provides evidence for increased asset concentration in the largest hedge funds compared with levels seen in the early part of the decade. However, recent data suggests a lull. A stable and even decreasing median portfolio fund size is a positive signal for smaller managers, at least within a certain range of the median. Furthermore, decreasing weighted underlying fund size coupled with a lower number of portfolio funds and increasing turnover, may be the result of poor performance among larger funds compared with smaller funds (which we see some evidence of over the past 12 months) and/or more redemptions from larger managers, lowering their portfolio weighting.

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