European Funds of Hedge Funds Consolidation ‘Necessary but Difficult’
Fitch Ratings says the recent wave of consolidation in Europe’s hedge funds industry leaves just a handful of candidates for large-scale acquisitions. In their quest for size, alternative multi-managers now focus on organic growth.
The credit ratings agency (CRA) adds that the same number of deals has taken place so far this year in the European fund of hedge fund (FoHF) industry as in the whole of 2011. The most notable include Man Group with FRM; Gottex with Penjing; AM Kenmar with Olympia and UBP with Nexar. In all cases, the rationale for acquisition has been primarily mutualisation of costs, economies of scale but also diversification of revenues and investor base.
Fitch believes that few medium to large-scale FoHF with assets under management (AUM) in excess of €2bn remain to be acquired. The notable exceptions are EIM and Gottex. Smaller players, with AUM below €1bn or €2bn, remain targets for acquisitions but obstacles exist such as poor financial condition, legacy issues, key person risk, in addition to the usual risks related to asset retention and cultural differences. In this context, many FoHF focus on organic growth, enhancing their core value proposition to raise assets.
The CRA says that traditional FoHF endeavour to position themselves as true alpha providers, in an industry tarnished by lacklustre performance. They need to demonstrate their skills in the selection of managers providing distinct, concentrated sources of alpha. Sourcing and research therefore now tend to focus on increasingly smaller, nimbler hedge funds which often operate below the radar of large pension funds. Furthermore, re-engineered portfolio construction aims to maximise uncorrelated source of alphas while creating downside risk protection at portfolio level. Fitch therefore expects FoHF managers to manage a concentrated portfolio by number of managers, but more diversified by risk factors.
It adds that FoHF managers work on becoming service providers to meet investor demand for flexible and transparent investment solutions: advisory, managed account platforms (MAPs), co-management of mandates, transparent client risk reporting are among the new services offered. These activities have lower fees than traditional FoHF management so that scale is needed to reach profitability.
Fitch concludes that investors will judge FoHF managers on their ability to re-establish appealing risk-return profiles and provide a greater level of flexibility in new services. This may be the last chance for many managers to achieve critical mass and ultimately remain in an industry still under severe pressure.