Alternative Market Briefing

Steinbrugge: Why the next 15 months will be the greatest asset raising environment in history of hedge funds

Tuesday, September 07, 2021

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Don Steinbrugge B. G., Opalesque Geneva for New Managers:

The next 15 months will be the greatest asset-raising environment in the history of the hedge fund industry, according to Donald A. Steinbrugge, founder and CEO of Agecroft Partners, a U.S.-based consulting and marketing firm. Asset flows will be driven by these three factors: the size of the hedge fund industry, manager turnover rate within investors' portfolios, and net flow to the hedge fund industry. So now is the time to travel and meet investors.

Size of the hedge fund industry

The hedge fund industry assets ended the 2nd quarter at an all-time high of more than $4.3tln (BarclayHedge). The majority of asset growth over the past decade primarily came from the compounding of assets due to positive performance.

Over the past 10 years, the hedge fund industry has been very Darwinian, says Steinbrugge. Manager turnover within investors' hedge fund portfolios has been responsible for almost all new asset flows to managers. Holding net industry inflows and manager turnover constant, the higher the hedge fund industry assets, the more new assets will flow to managers.

Manager turnover rate within investor's portfolios

The rate of manager turnover that fluctuates within the hedge fund industry can have a massive impact on new asset flows. For example, a 15% turnover rate of managers on $4.3tln in assets results in $645bn in new asset flows to managers. If the turnover rate increases to 25%, nearly $1.1tln will flow to new managers.

The manager turnover rate is typically driven by how investors perceive the relative quality of a manager versus others in their strategy, or by changes in target hedge fund strategy weightings within the portfolio.

Agecroft expects manager turnover to reach an all-time high in 2022 due to (1) pent-up demand, (2) the large dispersion of returns, and (3) changes in hedge fund strategy preferences.

The pent-up demand to hire new managers follows the reduced manager turnover during the pandemic. Allocations were typically made with managers the investor had met before Covid 19 or recommended by their investment consultant. But investors have gained confidence in virtual meetings, resulting in more asset flows in H1-2021. Agecroft expects travel to pick up in Q4 and next year, increasing the pace and efficiency of due diligence on new managers, and the levels of manager search activity - thereby manager turnover.

Market volatility in the last 18 months has led to large performance dispersion across managers and strategies. When relative performance is widely dispersed, the rate of manager turnover increases significantly.

That same volatility has changed investors' perception of relative value across the capital markets. This will impact investor preferences for hedge fund strategies and increase manager turnover.

Net flows to the hedge fund industry

The hedge fund industry saw net inflows of almost $149m in the last 12 months (BarclayHedge), after a decade of nearly flat net flows. Agecroft expects this recent trend to continue due to (1) strong hedge fund industry performance, (2) low interest rates, and (3) a two-tiered fee structure benefiting large institutional investors.

Performance over the last 18 months has sparked renewed investor confidence. During the last nine months of 2020 and the first six months of 2021, hedge funds delivered strong performance (about 11% and 10%). This renewed confidence will help drive positive net inflows.

Interest rates and credit spreads near all-time lows render fixed income strategies relatively less attractive. Many of these large institutional investors will continue to allocate away from low yielding fixed income investments to hedge fund strategies with higher expected returns and uncorrelated performance to the capital markets. Investors who do not view hedge funds as a separate asset class will invest part of their fixed income allocation to hedge fund strategies such as distressed debt, specialty financing, structured credit, reinsurance, and relative value fixed income among others.

Hedge fund fees have come down to an average management fee of 1.38% and a performance fee of 15.9% (Eurekahedge). What is typically not mentioned is the two-tiered fee structure that has been adopted by the industry. Most hedge funds are willing to provide significant discounts to their standard fees to attract large institutional investors. Furthermore, due to the volume of inflows, 1,144 hedge funds have closed to new money (Preqin). This is creating opportunities for new managers to fill the void.

What does all this mean to hedge fund managers?

For managers seeking to raise assets and build new investor relationships, this may be a once in a career opportunity to do so, according to Agecroft. Most hedge fund managers have spent very few resources on travel or marketing over the past 18 months. Now is the time to use those resources to get in front of as many investors as possible. The most efficient way to do so is to participate in cap intro events hosted by both prime brokers and independent companies.

Once investors work through their pent-up demand for new managers, Agecroft expects search activity to decline.

This heavy travel schedule is also worthwhile for managers that have had an unsatisfactory performance. "To reduce the likelihood of redemptions, managers should be sure clients understand what drove the underperformance and are confident in the managers' future performance."

The 3 elements most managers miss in their E-Capintro/Webinar/Video presentations

Although not new per se, digital channels such as online ("Zoom") meetings, webinars or videos are now widely used by investment managers as 1:1 or 1:N communications.

However, few firms have given thought to how to strategize and optimize their online marketing efforts and presentations. As a result, an exceeding number of investment managers are not fully reaping the benefits of the new communication channels, or worse, fail to score because of simple failures in their overall process, their presentation, or their attitude.

Opalesque has teamed up with Agecroft's Don Steinbrugge and digital marketing specialist Paul Das from ProfundCom for a MANAGER WORKSHOP on Sept. 16th on how to identify and master the three elements most managers miss in their E-Capintro/Webinar/Video presentations.

Gaining the Edge - Alternative Investment Cap Intro Jan. 19 - 21 West Palm Beach

Opalesque is a media partner and sponsor of the Gaining the Edge - Alternative Investment Cap Intro Florida 2022 which will take place in person on January 19 - 21 in West Palm Beach, Florida and will continue virtually until Friday, February 11.

This will be the first major independent cap intro event of 2022, taking place before 'hedge week' in Miami in order to not directly compete with three other, overlapping events taking place the following week.

The organisers expect it to be the largest and highest quality in-person and virtual cap intro event in the alternative investment industry. The recent Gaining the Edge 2021 virtual cap intro event was the largest virtual cap intro event in the history of the alternative investment industry with over 1,900 registrations.

The organizers are also offering a COVID-19 performance guarantee for all managers attending in person. If there is a resurgence of COVID-19, where the CDC issues a Level 4 travel advisory (or for non-US managers, if your government authority prohibits you from traveling to the event due to COVID-19), managers will have the option of switching to a virtual only registration and get a refund of the difference in price between an in person registration and virtual only registration.

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