Europe’s funds of hedge fund M&A doubles in speed

As much M&A occurred among funds of hedge funds by July as happened in all of last year, according to ratings agency Fitch, which singled out Switzerland’s Gottex and London’s EIM as among a shrinking number of mid- to large-scale European players not yet acquired.

Fitch noted there were just “a handful of candidates [left] for large scale acquisitions” and the alternative multi-management industry must “now focus on organic growth”.

The agency said investors would judge FoHF managers on “their ability to re-establish appealing risk-return profiles and provide a greater level of flexibility in new services. This may be the last chance for many managers to achieve critical mass and ultimately remain in an industry that is still under severe pressure.”

EIM may be a target for consolidators, but Gottex has been on the other side of the coin lately – buying up Asian peer Penjing. Elsewhere, Man Group announced its purchase of FRM, Kenmar has linked with Olympia and UBP has with Nexar.

Mutualisation of costs, economies of scale and diversification of revenues and investor bases has been behind the deals, Fitch said.

It pointed to asset size of below €2bn as a driver of M&A, but hurdles of poor financial condition, legacy issues, key person risk, and the “usual risks related to asset retention and cultural differences” existed.

The news from Fitch comes at a time funds of hedge funds, particularly smaller ones, are under intense pressure on various fronts. Global research from eVestment Alliance found products with under $1bn underperformed their larger rivals this year, over the last 12 months, and last year, by up to 2.4%.

The data monitors added: “Investor flows for funds of funds have not been positive for the last several quarters. In the first quarter of 2012, funds of funds experienced net redemptions of $7.3bn, while the hedge fund industry had net inflows of $31.4bn.”

This follows redemptions from funds of funds ($34.7bn) outpacing redemptions from hedge funds ($22.7bn) in the last quarter of 2011.

The one other time this pattern was repeated was in the second and third quarters of 2009 – some of the darkest hours for the FoHF industry.

Evestment Alliance noted: “For the fund of funds industry in 2012 to be faced with similar investor flow trends they faced post-financial crisis illustrates just how difficult the current capital raising environment and headwinds for growth are.”

Peter Laurelli, vice president, research, said: “To an evolving landscape of hedge fund investors, it is increasingly difficult to showcase a clear, superior value provided by funds of funds, specifically using performance comparisons over every possible sub-classification, to other methods of accessing the industry.”

The percent of assets in hedge funds from funds of hedge funds has hit a historical low of 36%, down from 38% a year ago, and from 49% three years ago. 

Fitch said FoHFs must either position themselves as “true alpha providers, in an industry tarnished by lackluster performance [by] selecting managers providing distinct, concentrated sources of alpha”. Here, Fitch said portfolios with fewer managers but more sources of risk factors were probable.

Or, FoHF managers could work on flexible, more transparent ‘investment solutions’. This would include advisory work, managed account platforms, and co-management of mandates, were among possibilities here. Man Group, Gottex and UBP have all been active in these areas. “These activities have lower fees than traditional FoHF management so that scale is needed to reach profitability.”

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