Like David bravely dueling with the larger Goliath, small and mid-sized investment firms are often faced with insurmountable odds when competing against larger (and better endowed) funds. With more experience and more assets, larger firms have the advantage when it comes to soliciting investor allocations. But do these inherent shortcomings equal certain failure? If David can emerge victorious, can’t smaller hedge funds?
Earlier this week, we gathered a panel of experts in San Francisco to discuss this topic at length. Following is a brief synopsis of the topics they covered.
In 2012, more than 90 percent of hedge fund allocations went to fund managers with over $1bn in assets. Interestingly enough, certain studies have shown that smaller funds actually provide better returns, despite their limited assets. An ICL study, for example, examined returns over a 16-year period (1994 to 2010) and found that excess return decreased as firm size grew (9.89% for firms with $10mm AUM or less; 5.45% for firms with greater than $1bn).
Despite performing well, smaller funds continue to require creative solutions to compete in the investment marketplace. Operational infrastructure is a critical component of any successful investment firm, and in many cases, can provide added value to small firms and help put them on par with larger funds. There are a variety of areas where small-to-mid-sized funds can look to leverage service providers and other creative outsourcing solutions to boost operations and appeal to investors.
Real Estate: Leasing commercial real estate space may not make the most sense for a firm with limited staff and budget. Firms should consider a hedge fund hotel or incubator space, whereby they may be able to leverage other services (e.g. administrative, technology, etc.). Avoiding real estate hotspots, so to speak, may also be worthwhile. For New Yorkers, a Chelsea or Tribeca office may reap greater benefits than a Midtown or Downtown location.
Technology: The reality is, smaller investment firms cannot afford to skimp on technology. Luckily, cloud services and other solutions can dramatically alter a fund’s budgeting, particularly when it comes to upfront capital expenditures. Investors are also keen to see firms leveraging third-party cloud solutions, rather than hosting their own IT equipment in-house and putting the firm’s critical data at risk for a disaster.
Accounting/Middle & Back Office Administration: Firms should carefully determine what types of middle and back office services they require and where they might be able to get creative. Can an outsourced administrator assist with accounting? These are often areas where outsourcing makes the most sense and firms can save on personnel costs while leveraging the expertise of third-party vendors. Compliance and human resources can also fall into this category.
Even with solid performance and operational infrastructure, it is still challenging for smaller investment firms to compete with their larger counterparts. A few possible advantages to remember for the Davids out there:
Smaller funds tend to deliver more alpha.
A smaller fund can access thinner markets than larger firms.
Many investors value a higher-touch service and more personal communications afforded by smaller firms.
Special thanks to our esteemed panelists for sharing their expertise this week in San Francisco!
Jason Gerlach, Managing Partner, Sunrise Capital Partners
Ted Bruenner, Portfolio Manager, Cypress Point Solutions
Joseph Doncheski, Chief Operating Officer, Kayak Investment Partners
Ed Tedeschi, Principal, Rothstein Kass
Mike Hartig, Director, Eze Castle Integration