How Much Does a Hedge Fund Need to Break Even?

Citi chart

(December 12, 2012) — It takes at least $250 million in assets for a hedge fund to be self-sustaining on its management fees alone, according to a survey by Citi Prime Finance.

The study determined that managers need between $250 million and $375 million in assets under management to break even and survive off management fees alone. These firms rely heavily on third parties for key business functions, the study said, noting that the largest hedge funds incur significant additional costs due to complexity and size.

This is the first global survey of the costs of establishing and managing a hedge fund business. It’s goal: to shed light on business expenses involved in running a hedge fund, and to provide benchmarks for hedge fund executives as well as for investors conducting due diligence into how managers run their organizations.

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“The cost of running an operationally sustainable hedge fund is substantial,” said Alan Pace, global head of sales and client experience for Citi Prime Finance, in a statement. “Hedge fund management firms of all sizes and lifecycle stages need to pay close attention to business expenses to the benefit of their firms and their investors.”

Sandy Kaul, US head of business advisory services for Citi Prime Finance, added: “This ground-breaking survey shows that smaller managers with assets under $250 million, which represent some 80% of all hedge funds and a quarter of total industry assets, are hard pressed to survive on management fees alone without capital injections from partners or incentive fees. At the same time, the very largest managers, about 1 percent of the hedge fund universe controlling some 60% of total industry assets, face steep costs due to diversified and complex portfolios.”

Read Citi’s full study here.

Citi’s paper follows an October study from financial software provider PerTrac, which showed that small hedge funds have a leg up compared to their larger rivals when it comes to long-term performance. It also discovered that during down markets the outlook for small funds is not as rosy.

“When you look at small funds, they’re generally younger. They’re trying to build up track records and they’re more likely to take risk,” Jed Alpert, PerTrac’s managing director of global marketing, told aiCIO at the time. “We see that smaller hedge funds also tend to have higher volatility.”

Related article: The Large vs. Small Hedge Fund Battle

(December 11, 2012) – What does it take to put together a global tactical asset allocation (GTAA) strategy like the Alberta Investment Management Company’s (AIMCo)?

Resources and planning, according to a how-to paper by AIMCo’s CIO/CEO Leo de Bever, Deputy CIO Jagdeep Baccher, Special Projects Adviser Ashby Monk, and Consultant Roman Chuyan. The report, “Global Tactical Asset Allocation for Institutional Investment Management,” details four key factors they discovered for implementing a successful GTAA approach:

1. A skillful team able to identify investment opportunities

2. A robust data management system delivering clean position and valuation information

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3. Clear accountability for strategy implementation

4. Timely, accurate feedback from management on team performance.

With these elements largely in place, AIMCo reports it is now adding 0.15% to 0.20% on top of its total returns. GTAA strategies tend to add these small top-ups to margins by taking advantage of short-term imbalances and mispricing. But the approach has more to offer funds’ bottom lines than “nickel and dimes,” according to the authors: “Once every decade or so, as in 2000 and 2007, GTAA can pay off in a big way, provided the right talent, systems, data and processes can provide the GTAA team with enough conviction to overcome fear of career risk in making decisions big enough to count.” Today, the paper continues, AIMCo “is now comfortable taking larger positions should a once in ten year extreme event present itself.”

AIMCo has $70.8 billion under management, and little oversight from the provincial or federal government. aiCIO took a look at a handful of state-of-the-art data management systems in the December issue, including AIMCo’s. De Bever told aiCIO it’s an integral part of the fund’s operation: “It’s risk exposure; it’s a current outlook on the markets; it’s your current asset mixes,” he described. “The system shows you where we’re making money and where we’re losing money. Most funds have something like this in a printed form, but that’s not dynamic—it comes out every quarter, at best…It’s worth the money.”

But not every fund has the capital to overhaul its IT infrastructure as AIMCo did. A bespoke system is ideal, of course, but other options are emerging for asset owners looking to better manage their data.

One company, a three-year-old start-up called Addepar, has about 80 Silicon Valley-types hard at work on off-the-shelf dashboard systems for private wealth funds, institutional investors, and family offices. (Off-the-shelf may be an exaggeration, but certainly they’re more standard than the all-custom job AIMCo uses.)

Arranging a skillful team, measuring their performance, and accountable implementation may all be within reach for highly motived small and mid-sized funds looking to pursue GTAA. At the moment, data systems could be the biggest hurdle.

But according to AIMCo, it’s these factors that make GTAA achievable for a broad range of asset owners: “In our experience, the key factor driving the success of our GTAA stems from the hard work we have done [to] develop world-class talent, systems, investment decision-making processes, and governance capabilities. Ironically, it’s these ‘mundane’ factors that have helped to create some of the most value in our investment operations.”