Will Both Large and Small Hedge Funds Survive?

September may in fact be the cruelest month of all, at least for hedge funds - now even worse than the previous "comeuppance month" just this last July (see previous post). Popular funds, such as Greenlight Capital and Maverick Capital had especially difficult months (see WSJ srticle and figure below), driving year-to-date losses beyond 15 percent and more.

Source: WSJ

Just recently many were asking the question: "Where are the big hedge fund failures?" (see previous post). At that time, many hedge funds, while down, were still doing better than the broader market (see previous post). Some of the funds that were struggling were hoping to see recovery before waiting periods on redemption notices were finally met. Unfortunately, the September sell-off has only made it more likely that investors will go forward with their plans and begin pulling money out of funds (see recent post).

As a result of potential mass withdraws, there is an expectation that as investors pull money out of funds, the larger funds are the ones that are most likely to survive. This belief is felt in part since large funds have more institutional clients, such as pension funds and endowments, which are less likely to reallocate funds to another manager, especially after putting so much money into hedge funds over the last few years. This could have a profound impact on the structure of the hedge fund industry given that three-fourths of the nearly 10,000 estimated hedge funds have less than $500 million in assets under management (according to data from Hedge Fund Research).

Yet, smaller funds have their advantages as well. While being more nimble with their portfolio as the market changes, they also have the ability to form a more personal relationships with their high net worth clients. In fact, a recent survey found that while an overwhelming 81 percent of wealthy investors were looking to change their advisor, only 29 percent of investors with smaller firms were looking to withdraw funds (see previous post). When all is said and done, clients need to put their money somewhere, and trusting it with someone they know, and someone who can hold their hand during difficult times, may help some successful small managers weather the current market sell-off.

It is quite possible that both large funds (due to experience, reputation and stability) and small funds (due to being more nimble and personable) may survive, as more mid-range funds (between $500 million and $1 billion) find it difficult to be flexible enough with their portfolios, or maintain the necessary personal relationships. Like election voters this fall, those in the middle may find themselves choosing between experience and stability versus flexibility and change. Of course, just as with elections, such choices are not always as easy or as clear-cut and obvious as they seem. The hedge fund landscape will no doubt change, but it may end up looking less different than anticipated. Furthermore, while looking structurally similar, the hedge fund industry, with its innovation, flexibility, and capital, may also end up doing more to help solve the current difficulties regardless of whether one believes they were the root cause of the problem (see Financial Times article).