Given the market disaster that was 2008, one would expect that any alternative investment firm that dipped its toe into the equity offering market is worse for the wear for becoming publicly held.
From London-based and London Stock Exchange-listed Marshall Wace on down to the many littler guys who lined up to list on the Irish exchange and others, both for permanent capital raising and for getting the rubber-stamp approval of being listed, it’s been a kind of given that in hindsight the efforts of going public weren’t really worth it.
Not so, according to a recent paper by Greg Gregoriou, Francois-Serge Lhabitant and Fabrice Rouah entitled “The Survival of Exchange-Listed Hedge Funds.” The paper argues that it was – and still is – more than worth it, if survival and longevity amount to anything. According to their research, the survival rates of exchange-listed alternative investment firms versus non-listed entities are significantly better.
Call it Survivor, hedge-fund style – the ones not voted off the island.
Their reasoning makes sense: Publicly traded firms are required to be more transparent, report information more frequently and most of all, adhere to regulations of exchanges. So while their stock price may make it seem like going public was far from worthwhile, their survival rate is much better than their non-public counterparts because they are following standards, guidelines and practices that private funds, for the most part, aren’t.
Another element: the concept of permanent capital, which we at AllAboutAlpha.com have focused on about from a private equity standpoint, in that a fund manager can put assets to work in long-term strategies without being hampered by cash inflows and outflows.
“This turns the famous dream of ‘permanent capital’ into reality,” according to the report’s authors.
Even after considering factors known to affect survival, such as size and performance, the paper’s conclusion – based on various estimators and models – indicates that listed hedge funds by nature tend to be larger and in turn more adoptive to conservative investment strategies than non-listed funds. Most importantly, the paper finds that the failure rate of listed funds is substantially lower than that of non-listed funds, though only during the first five years of life.
The chart below, which utilizes the Kaplan Meier curve for listed and non-listed funds, illustrates how the survival rate for publicly traded funds is significantly better two to six years out.
We at AllAboutAlpha.com and certainly many others have written about the rise and fall of exchange-listed hedge fund firms – from the go-go days of 2007, when hedge fund firms were tripping over one another to become publicly traded entities, to more recent times when the words ‘hedge fund’ and ‘IPO’ simply did not go together. (Click here for some of AllAboutAlpha.com’s coverage of hedge funds and IPOs.)
And certainly more than a few hedge fund IPOs never made it. Some died before reaching their optimal targeted operating size. Others decided to return assets to shareholders because of widening discounts. Indeed, the biggest challenge of listed hedge funds, according to the paper’s authors, is the potential discount or premium to net asset value (NAV).
During the panic of September-October 2008, for instance, average discounts to NAV surged to 20% from just 1% for hedge funds listed in London.
Still, many funds now have mechanisms that effectively control the discount. This mechanism allows them to invest in their own shares when the discount between NAV and the quoted price becomes large. The funds will then sell their shares at a profit when the discount becomes smaller.
Combine that with the slow crawl out of the deep, dark hole for equity markets around the world and one could potentially envisage a hedge fund IPO market coming back to life – a new dawn on the island, so to speak. Just look at UK fund firm Gartmore’s latest earnings, which suggest they may finally have turned the corner.
Maybe.
