New Funds Update: Start-up Funds Hold Firm on Fees

Although the chorus of complaints about hedge fund performance and fees shows no signs of quieting, there is one bright spot for the industry: Fund launches are on the rise. In the first three months of the year, 206 new hedge funds debuted, up from 183 in the last quarter of 2015, according to Hedge Fund Research. (Data for the second quarter wasn’t available as of this writing.) Many of the new offerings come from founders with impressive pedigrees. They include former Convexity Capital Management portfolio manager Edward DeNoble’s macro firm, Frontlight Capital, and Taconic Capital Advisors co-founder Kenneth Brody’s equity-focused Sutton Square Partners.

The trend of top portfolio managers striking out on their own comes with a caveat: Many are decamping from firms that are closing up shop. When that happens, the people who get left behind no longer have the option of going to the big banks, so many take the plunge and start new funds. Judith Posnikoff, a founding partner at Irvine, California–based Pacific Alternative Asset Management Co., says she expects to see some new firms sprout in the next six months — from the recent implosion of Visium Asset Management, for example.

But the industry’s performance has improved in recent months, bolstering new managers. Hedge funds posted gains for the fifth month in a row in July, the longest streak of positive results they have produced since 2013, according to HFR. The HFRI Equity Hedge Index gained 2.4 percent in July, for a 1.9 percent increase for the year. Macro strategies have gained 3.7 percent so far this year. “When performance is really good, we get a lot of launches because people want to set up in a favorable environment,” Posnikoff says.

Still, the hedge fund market remains extremely competitive. Though 910 new funds launched in the year that ended in March, more than 1,000 liquidated, according to HFR. And managers who strike out on their own now do so amid growing discontent over fees. Investors are increasingly questioning whether the returns most funds produce are worth what they are asked to pay for them. This has led to some pressure, as major investors have gotten more comfortable walking away from fees that are too high. Still, new firms don’t seem deterred from asking for 2-and-20, according to Posnikoff, who warns them of the dangers of hubris.

“To some extent, I think a lot of people are somewhat delusional,” she says. “I still see a lot of marketing books from people who haven’t even raised any money yet, or a very little sum, and they’re still quoting 2-and-20 and 1.5-and-15 for the founders’ class. You’re not really going to get that as a start-up unless people think you’re really a superstar.”