Emerging Market Hedge Funds Once Again Belles of the Ball

by: AllAboutAlpha

It’s hard to argue that being the most sought-after belle at the ball isn’t a pretty nice feeling. It’s also hard to argue that it’s pretty perturbing when a seemingly prettier, or in investment terms, less risk-adverse belle comes along and grabs the limelight, and all the fawning, attention and fun along with it.

So it’s been for emerging hedge fund managers over the past few years. Collective belles of the ball, thanks to investors across the spectrum tripping over each other to ride the next great emerging manager’s coattails, the attention and cash from pensions, endowments and foundations on one side of the coin and from high-net-worth investors on the other was more than illuminating.

That all turned into one giant ugly pumpkin in 2008 and 2009, thanks to the market downturn and pervasive sentiment that hedge funds in general and out-of-the-gate entrants in particular were no longer in vogue, and that prettier (read more liquid) opportunities were the better partner to tango with.

Well, emerging hedge fund managers apparently are getting their sexy back.

According to the most recent figures on new hedge fund launches compiled by Hedge Fund Research (click here to download the press release; the full report is available for purchase by clicking here), 260 new portfolios came out of the gate in the third quarter, an increase from the 201 new portfolios started in the second quarter and the 224 funds that kicked off in the third quarter of 2009.

For the year, some 945 new funds launched in the last 12 months, marking the largest number of new funds started in a 12-month period since the end of the second quarter of 2008 (see chart below showing total estimated number of hedge funds and funds of hedge funds through to the third quarter of 2010 according to HFR).

The main factor behind the pick-up in new launches: Strong capital flows and investors’ renewed penchant for at least perceived riskier assets, according to HFR.

The jump in launches jives with other recent surveys and reports indicating that not only are investors coming back to the emerging hedge fund party, that they are looking to allocate capital to emerging managers that have hunger, drive and of course capacity to take on money either in a seeding / partnership structure or in a straight, old-fashioned allocation format.

Indeed, a recent report by Preqin Research Group notes that the number of hedge fund investors expressing an interest in seed investments jumped to 21% this year from 11% in 2009.

To be sure, the industry is collectively nowhere near its heyday, where there were few barriers to entry and some 1,400 funds were hitting the pavement running every year between 2002 and 2007. With much more stringent transparency, liquidity and reporting requirements on the part of investors, being the belle of the ball means playing a lot less hard to get (Click here for AllAboutAlpha.com’s recent coverage of Scandia Investment Group’s survey on transparency and hedge fund allocations).

And not all hedge fund managers are willing to gussy themselves up in exactly the manner than investors are now expecting and demanding – or can’t really afford to buy the prettiest dress. Another recent report by consulting firm McGladrey and Greenwich Associates noted that when it comes to attracting institutional assets in particular, most mid-sized hedge funds simply don’t have the infrastructure and personnel to truly service those kinds of allocations.

Still, on the flip side of the equation, the number of liquidations is also falling. In the first nine months of the year, HFR said that 585 funds shut down, compared with 858 during the same period a year earlier (see chart below).

In other words, there were more launches than closures for the first time since the 2008 downturn.

So emerging hedge fund managers are back in the party which is good news for the industry - at least until the next better-looking belle with a prettier outfit shows up, or another mystical force rears its ugly head at the stroke of midnight and turns hedge funds back into fat ugly pumpkins.