Goldman Hedge Fund Report: More Consolidation Ahead

The one trend market pundits seem to collectively be predicting with ease for the hedge fund industry is so-called consolidation.

Which is why a list of the 100 largest U.S. hedge funds, ranked by equity assets, buried deep in Goldman Sachs’ (GS) recently released report on the state of the hedge fund industry, caught my late summer-diverted attention.

Among a few of the highlights of the 47-page report: U.S. hedge funds now have net long exposure near levels not seen since before Lehman Brothers’ collapse; that hedge funds now own 3.7% of the financial sector’s market capitalization; that 7% of hedge funds have closed since the financial crisis set in; and that managers collectively boosted ownership in financials by 55% on a quarter-over-quarter basis to $70 billion, with Bank of America (BAC) the favored stock pick.

Much farther into the report, however, is a snapshot that in and of itself provides confirmation of what many have been calling for in the industry for the better part of a decade: rationalization.

According to Goldman’s sampling, of the 100 top hedge funds, only five have more than $10 billion in equity assets under management. Another 12 have more than $5 billion in AUM, while 19 have more than $2 billion in AUM. Thirty seven have $2 billion under management, while the remaining 27 have $1 billion in AUM.

Renaissance Technologies LLC ranks No. 1 on the list, with $24 billion in equity-based assets, followed by D.E. Shaw $19 billion, Paulson & Co. with $16 billion, Adage Capital Advisors with $15 billion, Fortis Investments Management USA Inc. with $11 billion and ESL Investments Inc. with $11 billion.

The broader theme of the report is that hedge funds will continue to readjust their risk parameters, slowly taking on more by boosting their long-only equity exposure, as well as their short positions. What the report doesn’t directly touch on is the number of firms – and the average level of assets under management – that are or are about to engage in the re-risk process.

What the report is also indicative of, at least in terms of its measurement of the top 100, is the new and more sober landscape of what types of hedge fund firms will survive and thrive in the post-credit-crisis and market meltdown world.

To be sure, the sampling only looks at equity assets under management, and it only looks at U.S.-based funds. But the results paint a very interesting picture: The days of multitudes of multi-billion-dollar long/short hedge funds are over – at least for now.

Indeed, what Goldman’s “Appendix D” ranking illustrates quite nicely is the top 10 hedge fund firms in terms of equity assets under management are light years ahead of any of their competitors, while those in the $1 billion to $2 billion category are equally well ahead of their multiple-million brethren.

[click to enlarge chart]

In other words, the big are getting bigger, the small are staying smaller and those in the middle are shrinking.

It will be interesting to see if this is still the case a year from now. Even more interesting, and a topic we’ve touched on before, is whether the divergence between big and small will do anything to help returns.

Comments

[markfl:]

I have to imagine that the estimated $500 billion dollars in withdrawls must be an important reason behind consolidation. Cerberus imposed a three-year moratorium on withdrawls in two funds earlier this month. Some analysts predict this is the start of a trend.

Sep 14 02:24 PM

[BullnBear:]

I’ve been seeing a great deal of “regulation” and “hedge fund industry” mentioned in the same paragraph of many political articles recently. Consolidation may very well become a survival method for a wide ranging group of reasons.

Sep 14 02:26 PM

[Plant the s...:]

No doubt, this one has shaken the confidence of high net individuals in the magic of hedge fund returns


On Sep 14 02:24 PM markfl wrote:

> I have to imagine that the estimated $500 billion dollars in withdrawls
> must be an important reason behind consolidation. Cerberus imposed
> a three-year moratorium on withdrawls in two funds earlier this month.
> Some analysts predict this is the start of a trend.

Sep 14 06:12 PM

[Joe Duggins:]

Most people understand what a mutual fund is and think a hedge fund investment is the same thing. They are correct in that a hedge fund is a group of investors that pool their money, just like a mutual fund. Hedge funds, however, don't have the same type of regulation that the mutual fund has. In fact, you have to have a specific amount of wealth to invest in a hedge fund and a required amount of investment savvy. A hedge fund investment is not a public offering, but often a private limited partnership with the fund manager as the general partner.

Hedge funds do things because it is a private investment, which regular mutual funds can't do. One example is the ability to sell short. This is a risky technique especially if it's a naked short sale. The short sale is when you sell a stock in hopes of purchasing it later at a cheaper price to fill the sale.

A naked sale is one where you sell a stock you don't own. To comply with government regulations you must be able to borrow it from someone before you sell it. The reason that it's so risky is that the price could skyrocket after you sell the stock. Then you must pay huge amounts to fulfill your obligations to the buyer.

When large hedge funds use the techniques, often they drive the price down artificially in the sale of the stock and minutes later, can make a quick profit with the purchase and delivery of the cheaper stock. This is one way a hedge fund investment brings higher income than the traditional mutual fund.

The original purpose of a hedge fund was to hedge against the market's swings. The combination of different types of investments provided an equation against falling markets. The change came as hedge funds became more popular. Today, they provide not just a hedge against loss but an edge for gain.

The typical hedge fund investment contains derivatives that are high yield and debt from companies considered risks, so they have to pay more to borrow, or their loans sell at discounted rates which means the yield on the return is higher. If you use a $1,000 loan as an example, with the company loan rate at 8%, that is a decent comfortable return. Now, if that same company gets behind on the loan and the lending institution panics, they might sell it at a 50 percent reduction of the balance to the hedge fund. This in effect means that not only does the fund get 16 percent interest, but if the company actually pays the loan in full, they make a 100 percent gain on that money.

If you have plenty of money already, you may be the perfect candidate for a hedge fund investment. These types of investments are supplementary to normal investments. They attempt to defeat bear markets and bring in money while they also take advantage of the bull market and yield a higher return. There are risks in a hedge fund, ones that the average investor would never take. With the onset of a bear market, the technique of short selling is one of the best ways to hedge the bad market and take the lemon that the economy handed you and make lemonade.
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Sep 15 04:56 PM

[RiskAverseA...:]

My money is on most hedge funds, big and small, collapsing. Long financials? Each day nearer mid-term elections this play grows only dumber, as proof is seen in unprecedented political activism which no longer is willing to serve up free lunch to a bunch of monetarist parasites whose capacity to spin bald faced lies is waning faster than summer. Surely, as November 2010 approaches, serious calls for financial industry investigations will all too likely only grow to a deafening roar as the job-loss "recovery" proceeds unabated. It's bad enough that, equity in general is dead money buried under a mountain of increasingly unpayable debt. Bring on investigations surrounding the economic ramifications of the collapse of the grandest Ponzi scheme in recorded history (structured finance) and financials might just be the deadest equity of all.

A lot of people these days have been singing praises for the likes of John Paulson and his bet on BAC. I have two words for these folks: Peloton Partners. Last year was by no means an end, but rather a beginning. Snapping up equity in times like these is better left to money managers wishing to win first prize in the "World's Biggest Goat" contest. All one need wonder is who are these people going to sell this junk to, and is one lifetime going to be long enough to wait for bigger suckers?

Sep 15 10:05 PM