Small is beautiful
Erik Serrano Berntsen, the author of A Guide to Starting Your Hedge Fund and former consultant at Bain & Co. forecasts that investors will be increasingly comfortable with investing in better performing smaller managers rather than the industry’s behemoths.
There hasn’t been much media buzz about hedge funds lately. What’s the reason?
Hedge funds ‚Äì as a whole – have not performed terribly differently to the equity markets in recent times. In fact some hedge fund sub-strategies have underperformed in absolute terms. As public equities remain the largest component in most investment portfolios, people compare all other investments to an S&P or FTSE portfolio. With the immense easing in the system and the return of leverage, equity markets have performed extremely well. Hence the buzz has been less widespread.
On a positive note, there have not been many high profile blow ups or frauds, a sign that frameworks such as required independent administrators is improving the landscape. There has not been negative buzz either. Hedge funds, particularly in their early stages, deliver performance above that of other investments when one takes a longer term view. They manage volatility and downside better on average, than passive investments in equities or fixed income. We believe the buzz will return when the public markets suffer their unavoidable slip back to the mean.
What trends do you see in the hedge funds sector?
Contrary to the conclusion one would be justified in drawing by reading the generally negative stories about hedge funds, hedge fund assets have reached a historical high in 2015. This means the amount of capital in hedge funds is today greater than ever before whilst most stories about the industry point to high fees and poor performance. This trend in asset growth is driven by the ever increasing need of institutional investors to generate returns in a low rate environment with relatively low volatility and high cross-asset correlations. Large hedge fund investors such as pension funds are struggling with underfunded plans that need to meet a target return to pay out their beneficiaries.
Although the equity markets have done well, most investors agree that higher volatility and decreased correlations await in the next year. Active hedge fund exposure can be expected to do better in such an environment. Given the need for allocators to protect their own careers and invest in “safe‚Äù funds which are very large and count on strong brands, the trend is for most capital inflows to end up at a few behemoths. A small number of funds attract the majority of the capital. This is not necessarily good. We believe the final clear trend in the industry will persist: that small funds will continue to outperform large ones.