With the
mushrooming institutional growth of alternative investment managers, investment in the general partner is
also an asset play. Such investments are separate from the conventional
buying of hedge funds or other alternative vehicles as a limited partner. Private
placements of alternative vehicles and fund manager transactions arena is a
quietly burgeoning one, with dips. There are many global bank desks and
specialised others (FPM follows Park Hill Group), who are placing and
recommending hedge funds et al to global limited partner investors. At global banks within their Financial Institution Groups 'rain-makers' provide advisorial transactions in the actual management
firms of theses hedge funds. (FPM follow veteran specialists like Norton Reamer at AMF and Berkshire Capital). We at FPM suggests the financial services focus in
privately-held management firms is, industry-phase wise, more prevalent than M&A
activity in listed / public asset management firms; even though one of the
largest hedge fund managers is the UK-listed Man Group Plc with assets in excess
of US$ 50 bn, and who have been at the helm of major
transactions including mergers with GLG and FRM, over recent years.
M&A in fund
managers, or as we dub it for broader scope ‘Fund Manager Transactions’ (FMT), is both endemic and reinforcing
of growth and development of so called “alternatives investments”. Institutionalisation
of initially boutique alternative management companies over the last 20-25
years has given hedge funds, private equity, real estate, infrastructure and
commodity investments a wider investor-base through greater acceptance into
pension, endowments and other public portfolios. Remember, initially these alternative vehicles existed for mainly high net worth individual’s
or ultra-wealthy private family portfolios.
There would be a different set of financial
structuring and consequences were transactions occurring in the mature and
declining phase of the alternatives industry. Instead, FPM notices transactions which are spawning hedge funds. Such
spawns can become bubbles. The AOL and Time Warner merger at height of the Dotcom
bubble is a reminder of unintended consequences of trendy transactions. We
feel a sense of a milieu’s seismic shift
with outweighing negative outcome from this ‘splash’ phase of growth of
alternative investment managers. The author understands that a ‘feeling’ comes
before knowing, but in financial terms
FPM are flagging that asset-manager investments which are already reeling from
the financial crisis shock, will generate widespread losses for the
end-investor. As a case in point, Goldman Sachs’ private equity vehicle ‘Petershill’ consisting of hedge fund
manager stakes was put
up for sale in April this year due to operational, as well as performance
problems.
Few would argue
that our ‘feeling’ is poignantly prophetic in the current climate of financial
services reform from decades-long near-implosion excesses. Another example of
creative-destruction in alternatives: On shutting
down one of hedge fund sector’s oldest and biggest multistrategy platform
to date in July’12, Stark Investments'
co-founders, Brian Stark and Michael Roth, stated “…it has become apparent to
us that the financial markets have changed systematically over the past few
years…” The manager started operations as far back as 1986 and at its height
had US$14 bn AuM! (See link below for full story).
The starting point for creative-destruction
is the mutual expectation from capital flow in terms of its demand and supply
from counterparties. It is not just characteristic but almost a necessity for start-up or expansion hedge funds to have had
a significant investor / partner, long-term or for specified period. Diversification
of revenues and myriad other reasons suggest capital supply for businesses
exist. Indeed there are specialist publicly traded private equity vehicles
known as BDC’s (Business Development Companies) in the US. Similar to
REITs which are vehicles that focus on real estate holdings. FPM’s radar first registered Ares Capital Corp (ticker: ARCC) as BDC.
Therefore
financial intermediaries arrange stake buyers of alternative asset managers.
They take the form of cornerstone or minority strategic investor / partner
etcetera. Which is a matter of determining the degree of affiliation to the usually
independent partnership-structured asset managers. So clearly, with increasing institutional interest
in alternative managers it is implicit
that stake-buying activity is also rife.
This boom in alternative manager has systemic consequences
due the ‘shadow banking’ status of them, and implications of the degree of regulation
on them. Since the capital concerns of large banks presented liquidity and
solvency issues from the credit crisis, a lot of the void created is now
practised by hedge funds and the like.
A trend in manager-stake buying heightened to perhaps
unhealthy asset-bubble levels, unfolding since the
new Millennium, when "alternative investments" became an umbrella
label for any investment strategy other than long-only equity
and fixed income. And realistically there
was an emergent systematic sophistry of the traditional long-only investing. A
'game changer's' sophistry related to having an edge in understanding and managing corporate,
macro variables and/or events allied to regulatory-environment. Cynically, the ‘money
game’ being a mileu's socio-politico environment and resulting legislatures and economic capital
flows can be fixed!
Alternative managers are attempting to transform
themselves into global players akin to the
transformation of brokerage firms and traditional asset managers in the latter
half of the last century. Some of them are exhibiting bubble-proportion
problems in capital reserve ratios from capital destruction in the last asset
boom-bust cycle. “Big is no longer
beautiful!” is we believe a catchy euphemistic way of saying something is “old and non-dynamic”. FPM believes
Lehman Bros. and Bear Sterns’s financial failures from sub-prime-mortgage-loans
investments supports not only the thesis of diminishing trust in big banking model of global financial services;
but also that size of firm does not equate with fail-safe. Ultimately, those
venerable banks are prototype scenario for the creation and destruction of
capital wealth. In Lehman’s
case, human and financial capital built over 158 years to when the bank
declared bankruptcy in September 2008. Lehman’s ‘immigrant-idealized’ origins
started with an elder-sibling opening a dry-goods store, and evolving into
commodities-trading / brokerage operations, as an all-male sibling founders by
1850. And growing into a global financial services behemoth with assets of
US$600 bn, and eventually felled by its mortgage loans business and its
systemic financial inter-connectivity.
Equally as giant trees grow and wither over longer periods, so it is with shorter cycles in other assets, such as boutique hedge fund managers. Who clearly may or may not become best-of-breed giants, but certainly the risk is that “the bigger they are the harder they fall!” Regardless of its longevity and venerability; Lehman was also the 4th largest investment bank in the US, before its collapse.
So it is poignant
to note that, Hedge Fund Research Inc., reported that “…775 funds closed in
2011, the most liquidations…” of hedge fund investment vehicles since 2009. There
were approximately 10,000+ single manager hedge funds and, according to PerTrac
at end-2011 there were 13,395 hedge funds including funds of hedge funds. A
research study estimate for the mean annual attrition rate in hedge funds is
8.67%[1],
which we think is reasonable.
We believe the creative-destruction cycles are quicker
in the alternatives space. The relative rate of growth of assets in hedge
funds versus it procreator or predecessor, closed-end mutual funds, is a stark
statistic FPM possesses. Remember, closed-end long-only funds were the origins
of hedge funds, ETFs and multitude other pooled-assets vehicles. The first
such collective investment scheme in the world is Foreign
and Colonial Investment Trust, started in 1868. Coincidentally, the first fund of hedge funds is known
to have started almost 100 years later in 1969.
[1] Hedge Funds: Attrition, Biases and the Survivor Premium by Robert J. Bianchi∗ and Michael
E. Drew
