Newly started hedge funds received $12.4 billion in deposits from 2009 through 2011 from investors that believe many managers perform best during their early years, according to a Citigroup Inc. report.
Funds within their first year of existence received the allocations from 78 global investors during the three years, according to a Citi Prime Finance report being released today. Citigroup surveyed 90 global investors with $368 billion in assets, including funds of funds, family offices, private banks and endowments, according to Sandy Kaul, head of U.S. operations for the New York-based company’s business advisory practice.
“Performance in early years tends to be better,” Kaul said in a telephone interview. “Investors are looking to lock in the capacity with who they think are going to be the next stars.”
The top quartile of small hedge funds, or those with less than $100 million of assets, generated average annual returns of 99 percent from 2001 through 2010, according to an April study published by London-based Barclays Capital. Mid-size firms managing $100 million to $500 million rose 71 percent and the biggest funds gained 60 percent.
The opposite also proved true, with the worst-performing small funds losing 39 percent a year, Barclays said. Big hedge fund laggards had average losses of 28 percent.
Weighing the rewards against the risks of new managers, investors averaged two allocations each to early-stage funds in 2011. Startup managers had to attend as many as 100 meetings in order to win between two to four investments, according to the report. Investors made about five allocations each to new funds in the three-year period.
“Those are tough numbers,” Kaul said. “You need to really present yourself and position yourself in terms of how you compare to established managers.”
Twenty-seven percent of investors surveyed said they had programs currently in place to invest in new hedge funds, while 73 percent said they didn’t but would consider meeting with and allocating to early-stage managers, according to the report.
To attract capital, hedge fund startups often agreed to lower the fees they charge investors. The traditional 2 percent of assets and 20 percent of profits declined to 1.5 percent and 15 percent, respectively. Clients gave an average of $16 million to each new fund initially, compared with $37.7 million per established manager, Citigroup said.
Investors chose newer funds with an average of $193 million in assets and favored equity long-short among strategies, according to the report. Long-short managers can bet on the prices of stocks to rise or fall. Event-driven funds, or those that aim to profit from events such as mergers, and multistrategy funds were also popular, Citigroup said.
An investment team’s previous experience, track record and operations were the most important criteria investors considered in making day one or early-stage allocations.
U.S. investors were the most active allocators to new hedge funds and gave almost three times the amount of money given by clients in Europe, the Middle East and Africa and almost eight times those from Asia Pacific financiers.