“We see that inflows in the first half of 2010 appear to have been going almost exclusively to ‘mega funds’ of more than $5 billion in assets, whereas the rest of the industry has been, on average, flat.” Figures from research house HFR show that the top 30 funds by assets control 30 per cent of all hedge fund assets, compared with 20 per cent of all assets five years ago. The top 5 per cent of funds, or managers, control 75 per cent of assets. “This leaves about 6,000 hedge funds around the world fighting over just 25 per cent of the total spoils,” Keary says. “And surprisingly, the pace of concentration seems, if anything, to have increased since the financial crisis in 2008.” The nature of the hedge fund universe has changed dramatically in the past 10-or-so years.

Much of it is now channelled through fiduciary investors, such as pension funds, sovereign wealth funds and endowments, whereas in the early 1990s, when the industry started to take off, much of the funding came from high-net-worth individuals. Keary says: “Fiduciaries have multiple due-diligence teams requiring the fund to pass tests on multiple levels. Return expectations have dampened, high absolute return aims have been replaced by LIBOR-plus-something modest with low volatility and low correlation.” Increasingly, at least since the GFC, super funds with hedge fund allocations are looking for their managers to not allow the fund to blow up through poor execution, to play it safe. And they assume that the big brand-name managers are more likely to deliver in that regard. But are they? One thing is sure: there is no evidence that the big managers outperform smaller ones. As in the long-only space, the evidence is that, by and large, the more assets under management that a manager has, the less likely it is to outperform either the benchmark or smaller peers.

“I’m not saying that big managers are ‘bad’. It’s just that there’s no evidence that they’re better,” Keary says. The risk side of the equation is not so clear. There is a perception that large managers don’t carry as much risk as smaller ones. With increased transparency and with fiduciaries and their in-house management playing a greater role in the system this perception is also open to question. Keary says: “When we think about the hedge fund universe we see opportunity with what we call mid-cap managers. If we think about equity market volumes, they are in decline. So, it makes intuitive sense that managers which can generate good returns on smaller deal sizes may have the flexibility to prosper in this environment. Further, there is more chance to influence outcomes with these managers than with the mega-cap managers.” FRM has done some conceptual work – without live examples – which indicates that there is a sweet spot for alpha generation in between the overcrowded large end of the deal activity and the less-crowded but less-liquid small end.

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