Are Hedge Funds Getting Too Big?

Industry at $1.72 trillion; experts weigh in.

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1186279_weight_scale_Have hedge funds grown too big to live up to investors’ expectations? That’s the question posed by Reuters writer Laurence Fletcher. With industry assets at $1.92 trillion it’s certainly not a new question – hedge funds have been drawing in more and more institutional assets and it’s prompted some to wonder whether or not super-sized funds are nimble enough to weather crises – and exploit market inefficiencies. Fletcher’s article is below:

(Reuters) The hedge fund industry’s strong rebound from the credit crisis has prompted investors to ask whether some funds have grown too large and inflexible to keep delivering bumper returns for which the sector is famous.

The growth of big funds — helped by strong returns during the credit crisis and some clients’ belief that risks are lower than in start-ups — helped push industry assets to $1.92 trillion at end-December, close to the all-time high in 2008, according to Hedge Fund Research.

However, with the growth of big funds has come the old question of whether they could be stuck if another crisis hits, whether liquidity forces them into less profitable markets and whether their prized trade ideas will be discovered by rivals.

“By definition a supertanker can’t be as nimble as a speedboat,” said Ken Kinsey-Quick, fund of hedge fund manager at Thames River, part of F&C (FCAM.L), who prefers to invest in funds below $1 billion in size.

“They won’t be able to respond to market conditions, especially as markets become illiquid. They can’t get access to smaller opportunities, for example a new hot IPO coming out of an investment bank — if everyone wants it then you’ll only get a few million dollars (worth).”

Funds betting on bonds and currencies, and CTAS — which play futures markets — in particular have grown strongly.

Brevan Howard’s Master fund, which is shut to new clients, has grown to $25 billion after gaining around 20 percent in 2008 and 2009, while Man Group’s (EMG.L) computer-driven AHL fund is now $23.6 billion, helped by a 33 percent return in 2008.

Meanwhile, Bluecrest’s Bluetrend fund, which has temporarily shut to new investors in the past, has nearly tripled in size since the end of 2007 to $8.9 billion after a 43 percent gain in 2008. And Louis Bacon’s global macro firm Moore Capital has grown to $15 billion after a good credit crisis.

LIQUIDITY

While capacity varies between strategies, some clients worry about the time it can take a big fund to sell a security in a crisis. Even in today’s markets a small fund can sell a position with one phone call while it may take a big fund a morning.

“It’s even more difficult than before the crisis to turn around your portfolio. Liquidity in the market is not back to where it was. A fund of $20 billion in 2007 was easier to manage than it is now,” said Philippe Gougenheim, head of hedge funds at Unigestion.

“Because of poorer liquidity you’re paying a higher price to get in and out of positions. Given the current political and macroeconomic environment it’s important to be able to turn around your portfolio very quickly.”

Big funds may find it hard to keep trades secret long enough to implement them, especially when buying or shorting stocks. (Read the full article)

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