In 2012, large deals in the funds-of-funds segment of the hedge fund industry became a regular occurrence as fund managers sought out bigger partners in order to maintain their position in a difficult economy. According to Pensions and Investments, five of the top twenty-five hedge funds-of-funds managers have changed their ownership structure this year. This includes big names such as Prisma Capital Partners, FRM Holdings and the Rock Creek Group. As fund outflows continue to put pressure on the industry, all players are finding the need to step up their game in terms of securing reliable streams of future contributions.
Fee Pressures Continue to Weigh on Industry, Drive Transactions
One of the many pressures currently weighing on the hedge fund industry is the demand for lower fees from institutional clients. This is none more applicable than in the funds-of-funds segment. In the current environment of low investment returns, clients are struggling to justify the value of funds-of-funds management fees in comparison to do-it-yourself approaches to hedge fund investing. When it comes to sophisticated institutional investors, many portfolio managers are leaving this segment of the hedge fund industry and investing directly in smaller funds themselves, bypassing the middleman.
In response, hedge funds have actively begun cost reduction strategies in an attempt to make a lower fee environment still viable for their own margins. While in many cases this has meant a reduction in staffing levels, transactions can offer some advantages as well in terms of reducing costs. According to Pensions and Investments, access to Well Fargo’s distribution network was a key reason why Rock Creek sold a 35 percent to Wells Fargo. This sort of opportunistic transaction is becoming necessary for hedge funds to survive in this environment.
Low Fixed Income Yields Offer Opportunity for Hedge Funds
Large scale money managers have been an important and increasingly rare source of support for the fund-of-funds segment over the past year. With fixed income yields currently sitting at historical lows, portfolio managers are struggling to meet hurdle rates without taking excessive equity market risk.
Franklin H. Kettle, Managing Director of Colchester Partners LLC, suggested that traditional money managers need to consider funds-of-funds in order to retain clients in a time where low yields and high equity volatility are common place. “With low-yielding bond portfolios and wildly volatile equity strategies, companies like Franklin Templeton and others absolutely have to be able to offer hedge funds or be prepared to watch an awful lot of money walk out the door.”
Transaction Trend May Continue in 2013
While 2012 certainly saw a lot of new ownership arrangements in the funds-of-funds space, none of the underlying causes of these transactions are going away any time soon. Fee pressure is expected to continue in 2013 and fund managers will need to be creative in finding ways to lower costs while not sacrificing their investment management capabilities. Look for many of these creative solutions to come in the form of partnerships and strategic arrangements as the year continues.