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Number of hedge fund startups lowest in nearly two decades (bloomberg.com)
71 points by petethomas 5 months ago | hide | past | web | favorite | 62 comments

Former hedge fund manager here. It's a good summary, but there's a big piece missing. Setup costs are higher now, a lot of it due to regulatory changes. One of my contacts (and former customers) told me with recent European changes coming in, you need a good few hundred million bucks AUM to make it worthwhile.

A fair few potential founders would be able to find a few tens of millions from friends and family, but a lot fewer can find a hundred bucks. If you're backed by a big name this isn't a problem, hence you still get the occasional massive launch.

The part about the fees is also pretty important. 2/20 is from tales of yore. Any significant ticket will ask for a discount as well.

So it's just that much less attractive to launch.

More anecdotal evidence in support of this: a friend of mine with a lot of experience in the finance industry looked into starting his own fund, and determined that you'd need $150mm and a full time compliance officer on day one for it to be practical. Another friend did start a fund with a few million under management, but essentially just to establish a track record so he could raise enough money to be worth it.

Right. Over a chat before a professional event, a friend here said these days he'd want $200mm and compliance people and in 'the good old days' 100mm was plenty.

I don't know that there is any one regulation that makes this so.

AIFMD / MIFID come to mine although the regulatory burden seems quite low with those two (comparing to insurance Solvency II).

I would venture that the willingness for 2 and 20 has dropped to more like 1 and 10 or less. That would explain the double minimum size as well.

I guess it depends on how serious you are? If you're just one person managing money, including a significant amount of your own wealth, then I guess you can do things relatively cheaply.

If you want to grow big however, with a decent size investment team, the expenses all adds up quickly.

Institutional investors are not going to allocate capital to a team of one. You can outsource a decent amount of back office functions but you are still going to need to manage some things in house.

Yes, I am aware. But family offices will if you have proper relationships with them (essentially F&F money). You can raise small funds (i.e. $5 to $50m) from family offices.

If you can take 20% of an annual 10% gain on $50m, that's a million a year -- pretty great lifestyle wise for a one person band.

You make a few unrealistic assumptions, and you're ignoring opportunity cost. Small funds charge more like 1 and 10-15%, your example assumes 0 and 20%. You ignore expenses; besides the normal costs of any business, like legal and accounting services, hedge funds usually have a Bloomberg Terminal ($24k/year) and usually other expensive research, as well as expensive compliance and fund administration services. $50mm is a lot of money to raise unless you know a lot of rich people and have an established track record as a good investor. Someone like that can make a very good salary as an employee of an established fund, and not have to deal with the extra hassle of running a business. The flip side is they probably also have a high net worth, and are keeping 100% of the gains from whatever they personally invested. But on balance running a $50mm hedge fund isn't as much of a slam dunk as you might think. The regulatory and investment environment is pushing things to a winner take all situation, where there are fewer, larger hedge funds.

Those are horrible returns, that is borderline nearly unethical. You would have higher returns and pay less than 1% just putting it in the vanguard 500.

It depends. If you actually made 10% a year, every year for 20 years, and never lost money:

A) You are either Jim Simons or Bernie Madoff.

B) Investors would be tripping over themselves to pay 20% fees.

Higher than 10%? Only if you've been following the market for the last 7 or 8 years.

Average market returns will be closer to 6 or 7%.

Different investors have different investment priorities.

“If you want to grow big however, with a decent size investment team, the expenses all adds up quickly.”

Wouldn’t this be true for any startup looking to “grow big”?

There's data that disputes the couple of hundred million to break even story.

Source: https://www.hedgeweek.com/2017/07/11/253832/emerging-hedge-f...

“The key finding of the survey is that these managers can be profitable at a small size. One third of managers surveyed said they were profitable with less than USD50 million. We therefore dispute the claim that you need USD200 million or more to break even. We think there is tight evidence that you can do it at a lower AUM number,” asserts Capstick.

Breaking it down by strategy, the survey found that global macro funds need the most assets to break even: USD132 million, followed by event-driven (USD108 million) and multi-strategy funds (USD98 million).

No one goes into this business to breakeven.

I'm very doubtful that a majority of these smaller funds survive very long but really no great way of knowing. Macro funds until this year have just been sucking. Let's say you're getting 1/15 on 132mm and returned 10% (10 is generous given how a lot of these funds have performed) for the year. That's 1.32mm management fee and 1.98mm in incentive for 3.3mm total. That's really not a lot of money to go around to get startup hedge fund talent.

Setup costs aren't that much to be honest. Some prime brokerage depts at banks will even help you get started, often for an ongoing portion of your fund's management fee, so there isn't anything to pay at the start. They'll even handle compliance, monitoring and accounting for you.

Generally, you can get your fund going for under a 100k GBP in London, providing you have the required regulatory capital (if you're going down the regulated route, that is). Hiring people, office etc etc gets expensive, but a lot of 'funds' we've helped set up are 1 or 2 man bands, working out of a co-working space with colo'd execution infrastructure in Equinix, based out in Slough.

Talking about "colo'd execution" makes me think you are thinking of a particular strategy which the costs make sense for but not the rest of the majority.

Do you have any sort of documentation about this (although I am in the USA)? I'm starting a mini hedge fund now with so much less money (under 6 figures) and perhaps I'm missing something?

How can you make money with a mini hedge fund? I've looked into setting up something, and at the minimum you'd need a few million (and that's even keeping everything super lean) for it to make sense money wise.

Well, so far everything I am doing is 99% automated based upon my own tools, etc.

Edit: Dr. Ernest Chan has written 3 really good books on Quantitative/Algorithmic trading. Essential reads.

What platform are you using for trading/algo?

A few dideferent platforms. AlphaVantage, Interactive Brokers, other data platforms too.

have they been useful yet, or just sounded good?

Extremely useful. Plus Dr Chan was helpful when I emailed him with a few questions about concepts in his books.


You might want to consider classification as a "Proprietary Trading Firm" instead of a hedge fund

This actually makes more sense, I am discovering. Thanks for bringing it up as I just sort of made up mini hedge fund as a term

IIRC Hedge fund has to be funded by accredited investors, and usually have significantly more capital than under <1mm, but I'd imagine you would want to co sult a securities/specialist legal counsel for a question on forming a fund

Depends on who's money your accepting really. Outside money = lots of red tape

Yeah, none of the MIFID compliance stuff is easy and it's to the point where you don't want European investors if you're an American entity.

> A fair few potential founders would be able to find a few tens of millions from friends and family,

Rich kids

One of the major trends in last two decades is increased correlation (especially during bear markets). No matter how you diversify the portfolio, it will correlate with others more. There is more correlation between individual assets and between different asset classes.

Between 1980-1999 the correlation between US and foreign stocks was 0.47 - 0.49. Between 2000-now its 0.88-0-89

Moving between stocks, bonds and alternatives produces declining value relative to the past. U.S stocks correlate more with international stocks, bonds correlate more with stocks, raw materials correlate more with the rest.

I think it's natural to expect less value from hedge fund strategies in general. Maybe private equity investing helps but how much?

The majority -- perhaps the vast majority -- of headge funds are long/short funds.

In the canonical example, if they think that Pepsi will perform well because of some new health products, then they will go long Pepsi and short Coke. The idea is that all the other events they haven't looked at: a crash, currency shifts, people decide sugar is bad for you, NYC soda ban etc will hit both companies equally hard. The only thing they want to bet on is their single hypothesis.

They can't always do this cleanly, but to the extent they can, they diminish some of the risk around the correlation of asset classes.

Isn’t that the opposite of a hedge? A put on coke would increase the risk of a long bet on Pepsi

If I'm reading this right, they're getting outcomes like this:

* No crash/external event. Coke goes up. Pepsi goes up more due to health products. They're out money on Coke, but make enough on Pepsi to cover it and then some.

* Crash/external event. Both drop. Pepsi drops less because of the health products. They lose some on Pepsi, but because Coke dropped more, they make more off the Coke short than was lost on Pepsi. They still come out ahead.

* If the health products have no effect, then the gain or drop will be similar, giving roughly net-zero cost/gain.

The real risk, as I see it, is that the correlation breaks the other way, and Pepsi drops while Coke goes up. That's the price you pay trying to make a bet on something - the fund is safe from external events, but you can't hedge against being dead wrong and still make a profit.

> they will go long Pepsi and short Coke.

Have correlations stayed same in pairs trading?

Interesting point on why increased correlation hurts traditional stock pickers and market timers. Does this make a case for quantitative hedge funds doing better?

Quant funds are in a good position to put on a large basket of long and short positions (with leverage), and therefore can separate individual stocks from their confounding market factors. Of course, it presumes the fund has a strategy giving them enough conviction to bet on individual stocks / securities.

Is this a sign of an asset bubble, a consequence of globalization, increased trading sophistication, or something else?

The increased correlation is a sign of more integrated economies (globalization).

For instance, the US is highly dependent upon China for manufacturing. So when the US hits a recession, and we spend less money, less money goes to China as well, causing lower growth or a recession on their side.

That's simple correlation example, although there are second and third order effects that are significant as well.

Independently, bubbles have their own flavor on top of that, but usually concentrated to a particular sector (could be a straightforward sector like "tech", or as large as "equities", as was the case due to central bank easing around the world).

Trading sophistication tends to cause faster reactions (e.g. currency goes down, but their stocks go up in the same day, or even same hour). Decades ago, the trading was not as interlinked, so people couldn't make a global decision an implement in multiple markets at the click of a mouse.


Former hedge fund manager here. This never gets mentioned, but there are fewer publicly traded companies than there were in the late 1980s. There’s more money and fewer opportunities for a hedge fund to differentiate, so it’s harder to get outsized returns without excessive risk. Meanwhile, the finance industry has convinced people it’s “impossible” to beat the index in the long run.

> Meanwhile, the finance industry has convinced people it’s “impossible” to beat the index in the long run.

Did the finance industry do that? All I see when I look at the finance industry is people desperately trying to convince me that I can beat the index if I give them lots of money. I think what convinced people it’s impossible to beat the index in the long run is the continuous failure of active funds to do that.

That doesn't explain non-equity strategies sucking too.

Thank you ETFs. On the other hand, in finance and investing, what is old is new. I don't doubt that hedge funds will have a resurgence or that active money management will find footholds in different vehicles. For example actively managed ETFs.

'Actively managed etf' is an oxymoron.

No it isn't.

The SEC approved it with this exact language

> Applicants request an order that would allow Funds to operate as actively- managed exchange traded funds (“ETFs”)

It happened back in 2017 in Investment Company Act Release No. 32810.

Not sure how you missed that.

Why? You can have hedge fund strategies embedded within the legal structure of an ETF.

I think you mean 'active index fund'.

Interesting points on volatility and the rate environment. I wonder how much is other big picture issues.

- The buyers are getting more savvy and don’t want to pay high fees for whatbthe can do in house.

- More high risk money is going to private securities.

- For some strategies (derivatives) there are less people to trade with. (Fewer suckers in the game)

- Fewer smart people are going into finance. (I’m not sure this has gone on long enough to impact hedge fund startups)

Low vol and rate environment is the primary cause which kinda drives your first two points. Investors aren't allocating as much to alts and what they are is shifting more to PE. PE did well over the last crisis because of long lockups and mark to model vs mark to market. Any hedge fund that invests in public securities doesn't have that luxury to tread water.

As far as your first point goes, I don't think investors are getting more savvy but they are under pressure due to bad performance and high fees associated with some of the funds they invested in. Generic long/short equity funds are more or less able to replicate in-house and some are trying out ETFs to sub for other strategies but none of these have the same return profile as the actual strategies.

My impression is a lot of LPs are asking “why am I paying 2/20 or 1.5/15 to get returns that are either 40% correlated to a passive fund, or don’t beat the market?”

I think another big issue is that it’s just plain hard to beat the market on a consistent basis.

Yes, agreed but am wary of comparing any proper hedge fund's returns over a short time frame vs the market. They are supposed to be absolute return vehicles. By nature of (supposed) uncorrelated returns, a lot of funds are not going to beat the market if it just goes up and to the right but definitely should be outperforming in other markets.

You can beat the market in two fundamental ways:

1 - Higher returns 2 - Lower volatility

Effectively, everything else is a variation on those two (e.g. same returns with lower volatility; or really low volatility, but better than the AGG; or really high returns with really high volatility (highly leveraged funds) ).

The reason this is important is because different investors want different things. If you can beat the AGG at the same or lower volatility after fees, then it doesn't matter how much you charge - people will beat a path to your door.

One interesting example is Renaissance Technologies. Several months ago I was reading through their SEC filings, and if IRC, they charge 4 & 40 ! Yes, FOUR and FORTY - to their own employees! For the record, it's a monster fund, and you can't invest in it unless you work there. Yet people will do anything to get a job there and pay those fees because the fund is so good.

>Hedge Funds Trounced Markets Over the Long Term

Looks very iffy to me. Googling survivorship bias "The flagship investable HFRX Global Hedge Fund Index, for example, has undershot the non-investable HFRI Fund Weighted Composite Index every year since 2003, by an average of 560 basis points." https://www.ft.com/content/16e4fb60-46ad-11e0-967a-00144feab...

knocking that off the 10x 20 year return shown for the HFRI would reduce that to a 3.6x return

How it works is a fund company launches the super fund and the wow fund. Then the super fund goes up 20%, the wow down 20%, then as a holder of the wow fund you get a letter "the wow has been discontinued and merged with the super fund" Then the company claims all its funds are up 20%. An awful lot of them pull that kind of thing and you have to correct for it to get useful stats.

So... does that mean this is the best time to start a fund because there is little competition?

Or the worst because there is little opportunity?

I would hope that Buffet bet is solely responsible for this trend but people are not that smart to accept actual proof that something that they believed in for so many years does nothing beneficial or even does harm.

I imagine Buffett has played a part both with his bet and arguing against them as a wise investment.

I always figured hedge funds thrived in more volatile situations. The years of consistent-yet "boring" growth that we have seen since the recession is not a fertile environment for alternative strategies.

Some play volatility. It’s also a game of betting against the trend. When the trend goes in one direction for long enough, you get burned taking the other side.

How and why does this happen?

I dont quite understand what would encourage someone to take outside investment money unless its necessary to build production.

Maybe I'm so small time, I just dont understand, but Snapchat survived without taking investment from my understanding.

I think maybe you don't know what a hedge fund is? Because your question doesn't really make any sense?

Anyway, the answer is: hedge funds want to take money for 2 reasons:

1. The bigger the hedge fund, the more famous the manager is. They get to meet Presidents, talk on CNN, get invited to Davos, and other famous people perks. You get to say you "won". 2. The hedge fund charges fees based on the assets under management; the more money you take in, the more money you personally make.

thank you!

>Snapchat survived without taking investment from my understanding.

Ignoring the cost of development (which is reasonable given how simple the app was when it launched), Snapchat has incredibly high infrastructure costs. It runs on google cloud (you pay a huge markup for cloud services - it's just often worth it because you can scale up and scale down to match actual need but I assure you snapchat was not scaling down) and is media heavy (read high bandwidth bills).

Snapchat received $2.65 billion in investment pre-ipo!!! $2.65 billion!


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