Alternative Investment Management Association
The year 2006 turned out to be another action-packed time for hedge funds, dominated from a news perspective by the high-profile blow-up of Amaranth Advisors but ending with robust performance overall – and a further robust increase in industry assets. The latter part of the year and the first few weeks of 2007 also brought a flurry of activity – spanning acquisitions, buyouts, IPOs and fund flotations – signalling what looks like a dramatic acceleration in the reshaping of both the hedge fund industry and the wider asset management landscape generally.
In the US, the Absolute Return Composite Index ended the year up 11.22% , its best return since 2003. In Europe, the EuroHedge Composite was up 9.60% , also the best for several years and with equity funds doing considerably better, posting average returns in the mid-teens. In Asia, the AsiaHedge Composite reached 9.20%, dragged down only by a negative year for Japan, with funds elsewhere generally producing gains in the high-teens or above.
There also continued to be a strong flow of new funds coming through, although an ever higher proportion these days are coming from established firms rather than pure start-ups and aggregate assets raised seem to be levelling off. In the US, the latest Absolute Return survey found that there were 86 launches of over $50 million in 2006, raising combined assets of about $31 billion , down a bit from $34 billion raised by the biggest launches of 2005 and some $40 billion in 2004.
The latest AsiaHedge survey found a similar picture, with a total of 122 new Asian funds in 2006 raising about $7.2 billion, again slightly down on 2005, when there were 126 new funds raising about $7.5 billion. At the time of writing, the EuroHedge survey of new funds in Europe was not yet complete, although we were expecting its findings to buck the global trend and show a further rise, given the arrival of some very big new funds in the latter part of the year. In the first half of 2006, there had already been over 170 new funds in Europe, raising about $11.5 billion.
While the growth of the new fund market may be levelling off, the same cannot be said of the industry overall, reflecting the fact that, as investors pour more money into the business, the lion’s share of it is going not to new funds but to established players. By the mid-year point of 2006, the Absolute Return Billion Dollar Club, including only those firms with hedge fund assets of over $1 billion, had reached a collective total of very nearly $1 trillion. By the same time, the collective assets of European hedge funds had soared past the $400 billion mark, while Asian fund assets had reached nearly $130 billion.
By early 2006, we had calculated that the global industry overall, (if you also include the legion of smaller ‘non-billion dollar’ groups in the US, plus those in the other small but fast-growing markets such as Brazil and South Africa), had passed aggregate assets of $1.5 trillion. By the end of the year, the total was racing on towards the $2 trillion landmark.
This conclusion is backed up by our statistics on fund of funds assets, which are collected by InvestHedge. Over the year, the InvestHedge Billion Dollar Club, including only the 142 largest fund of funds groups, grew by a collective amount of nearly 30% last year to reach combined assets of $820 billion. If the smaller groups running assets of under $1 billion are added and InvestHedge tracks a further 440 of those firms, then funds of funds overall must now be running close to $1 trillion.
For many years, industry observers have been confidently predicting the eventual demise of the fund of funds sector on the basis that, given the extra layer of fees, investors would sooner or later cut out the middle man and go direct to the funds they want. The statistics continue to show this simply is not happening – or at least not yet.
Ironically, the biggest negative news event of the year, (the sudden collapse of Amaranth), in some ways demonstrated, yet again, just why funds of funds continue to be the most popular route for end-investors. While it could certainly not be described as good news for those fund of funds groups who allocated to Amaranth, their end-investor clients will generally have lost a lot less than investors who went direct. For most fund of funds groups affected, it ultimately became a performance issue, taking some of the shine off gains made elsewhere, rather than a life-threatening blow.
A big and established firm losing some $6 billion was nevertheless a big shock; probably the biggest to hit the industry since the near-collapse of Long-Term Capital Management in 1998. It was remarkable how the markets appeared to absorb the event so easily, seemingly without missing a beat. However, while the market may have been relatively unscathed, the same could hardly be said of the fund’s investors, who (by being subject to its lock-up terms), bore the brunt of it.
Furthermore, while the market may have coped this time, everybody has become more aware than ever, given the much greater scale and importance of hedge funds today, that the same might not be true with the next big blow-up. Hence the pressure that had already been building in the US and elsewhere for regulators to apply new and tougher rules on the industry has certainly not gone away.
By early 2006, most hedge funds in the US had already moved to comply with new registration requirements for hedge funds imposed by the Securities & Exchange Commission (SEC) although these were subsequently thrown into limbo after the SECs authority to impose registration was successfully challenged in court. Since then, some firms have subsequently decided to de-register, while a smaller group of leading firms, including Amaranth, by taking advantage of the SEC exemption for funds with lock-ups of two years or more, had never registered in the first place.
Although it is not yet clear what precise new rules the SEC may be empowered to propose next, it is already widely expected that some sort of new requirements, including registration, will ultimately be imposed because the industry has simply become too big and important a factor in the markets for the agency to ignore.
The growing importance of the industry is also making it more increasingly visible on the public markets, both for the increasingly activist stance of many hedge funds in listed stocks and for the creation of new listed vehicles by hedge funds themselves. Hedge funds have of course become increasingly involved in disputed public M&A activity, including most notably the Deutsche Borse in 2005, which has inevitably attracted increasing media attention for the industry.
Alongside this there has also been a continuing blurring of distinctions between hedge funds and other asset classes, such as traditional asset management and private equity, with many traditional firms becoming more active with hedge funds and many hedge fund groups adding long-only or quasi-private equity products and hybrids. The new UCITS III legislation in Europe, paving the way for 130/30 hybrid funds, has given this trend a further stimulus.
Man Group has, of course, been listed on the London Stock Exchange for many years and become one of the market’s most highly rated stocks. The new wave of listings really began back in 2004 with the listing on AIM, the junior London stock market, of RAB Capital plc. This has since been followed by various other, mostly smaller firms, though one of the next aiming at an IPO - Fortress Investment Group in the US - is a really big one involving a giant in both hedge funds and private equity.
RAB was also a pioneer of listed vehicles raising ‘permanent capital’ for a specific fund strategy, with the listing of its RAB Special Situations Company in 2005. This began another trend that really started to gather some steam in 2006. Other major players who successfully created such ‘permanent capital’ vehicles during the year included Boussard & Gavaudan Asset Management, with its Sark Holding vehicle, and then Marshall Wace Asset Management, which was heavily over-subscribed for the MW TOPS vehicle, raising over €1.5 billion.
With these players raising money so successfully, it should be no surprise that other leading groups seem to be lining up to follow suit, with Brevan Howard, the biggest macro player in Europe, being one of the next proposing to do so.
Meanwhile, the need to be among the providers of hedge fund products has also been driving the big investment banks and financial groups to take stakes in hedge fund groups, offering hedge fund founders another way to cash in some of the value of their businesses. Morgan Stanley was the biggest mover on this side in 2006, sinking no less than three big deals late in the year, with the acquisition of 20% stakes in Avenue Capital and Lansdowne Partners, plus the complete buy-out of FrontPoint Partners. Industry M&A fever even spread as far as Asia during 2006, with Sparx, the biggest listed group in Japan, buying out PMA, the biggest in Hong Kong.
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It is clear from all of these developments that the increasing ‘institutionalisation’ of the hedge fund business that has been talked about so much in recent years is now entering a new phase, where the ‘alternative’ is becoming increasingly main stream.