New Funds Update: Is Bigger Still Better?

To look at 2015’s new hedge fund launches and those planned for the coming months, it’s clear that bigger is still better. The impact of the financial crisis, which sent so many investors flocking to the safety of large, established managers, has endured despite improving economic conditions and evidence that smaller hedge funds produce better returns.

“The barriers to entry are getting bigger and bigger, so as this becomes a more institutional business, we’re seeing that there’s more and more of a need for scale to meet the demands of institutional investors,” says Keith Black, head of curriculum at the Chartered Alternative Investment Analyst Association and a former trader and consultant.

But experts say there is some evidence to show that the trend toward megamanagers may be starting to shift. Although the flight to safety made sense in the wake of the crisis, this strategy has not worked well for investors lately. Hedge funds of all sizes have suffered this year, despite the belief that investing with a large firm will shield investors during volatile times.

“Clients are realizing that they’re not actually getting better performance,” says Arvin Soh, a portfolio manager in the alternative-investments solutions group at asset management firm GAM in New York.

Soh’s views are supported by recent research by three professors at the Cass Business School at City University London who found that small managers outperformed their larger peers — especially during market dislocations — from 1994 to 2014. Soh says GAM’s smaller funds have consistently outperformed larger ones for most of the past decade.

“The funds that exist now, including the smaller ones, are a much higher caliber institutionally than they were even just five years ago,” he explains. “That safety that people say they get with a large firm, they’re actually getting a good amount of that with a small firm now also.”

This shift is still in its infancy, however, and it won’t be clear whether it will hold until well into next year, Soh says.

Meanwhile, much of the seeding capital and new investments will go to large funds managed by big names. Michael Queen of 3i Group is launching a long-short equity fund focused on water and waste sector investments called Aquilys Investment Management. Shilpi Chowdhary reportedly is opening a new quant fund under the Ataraxia umbrella. And Miguel Fidalgo, formerly of Boston-based Baupost Group, plans to launch a new special-situations fund called Triarii Capital Management with about $300 million early next year.

Investors, it seems, are still willing to pay for pedigree.