Hedge Fund Investing: A Practical Approach to Understanding Investor Motivation, Manager Profits, and Fund Performance

Current State of the Industry

Today, net inflows continue to go from large well-researched institutional investors into large well-established hedge fund managers. The big single-manager funds are getting bigger at an increasing rate. Smaller funds are beginning to struggle to attract capital and maintain scale, as barriers to entry begin to form in the hedge fund industry.

Some traditional intermediaries like FoFs are losing assets and not seeing new inflows. Investors today want to deal direct and challenge the value proposition of most FoFs. Funds of hedge funds operating in boutique markets or regions will continue to gather assets; however, the influence on FoFs in the sector has significantly declined. Many FoFs have been forced to close by the combined impact of fee pressure, fewer assets, and the need for more due diligence and transparency that is now demanded by the investor base.

According to HFR data, more than 80 percent of all funds of hedge funds lost assets due to redemptions in the fourth quarter of 2011, whereas less than 20 percent had net inflows. Hedge funds as a group fared much better, with only 60 percent experiencing net outflows and 40 percent experiencing net inflows.

In the early days of hedge fund investing, there were very few barriers to entry, and the probability of success was rather high. Today, barriers to entry are emerging as the industry matures and funds incur additional costs to meet investor demands, conform to best practices, and meet regulatory ...