While the operating environment for smaller funds remains challenging, they are attractive to investors who value their independence and do not wish to become reliant on a few very large funds. Encouragingly, clients appear very open to consider committing funds to smaller managers.
The outlook for emerging managers remains bright
While emerging hedge fund managers are negotiating a tougher start-up environment characterised by leaner operating models and challenging fundraising conditions, there is some good news on the horizon. Namely, around a quarter of hedge fund clients responding to IG Prime’s annual 2025 State of the Hedge Fund Industry report were planning to change hedge fund manager in the next year, and 42% of those respondents said they were seeking a smaller manager. A further 33% said size was not an issue, while just 25% were seeking a larger manager.
If you are seeking to change managers, what are the reasons?
The positive case for emerging managers
Figures from the Alternative Investment Management Association (AIMA) echo the results of our survey. AIMA found that two-thirds of the investors it surveyed were open to allocating to emerging managers with less than $100 million in assets under management.1 An improving fundraising environment should also support emerging fund launches. New hedge-fund launches picked up dramatically in 2024, driven by falling interest rates and rising risk appetite.
Hard data supports the view that clients are open to investing in emerging managers. Although large firms garnered the majority of the $15.86 billion of inflows into hedge funds that took place during the third quarter of 2024, emerging hedge funds performed strongly and certainly better than their medium-sized counterparts, which saw outflows of $4.9 billion. Firms managing less than $1 billion at the start of the quarter received strong inflows of $5.3 billion, bringing the total inflow for the first three quarters of the year to $8.8 billion.2
Moreover, while emerging managers say they are particularly challenged by rising costs, lacking the deep pockets of the huge funds, with the average break-even point increasing since 2022, they do have other advantages that suggest emerging funds can continue to prosper. These include:
• The fee model offered by emerging hedge funds remains a vital tool for attracting investors, with average management and performance fees well below the classic 2-and-20 model.
• They are more accessible than the very large players – investors can often speak directly to senior investment decision-makers at a boutique firm, rather than having to work through a larger manager’s investor relations team.
• They can take advantage of investment opportunities that aren’t large enough for the very big firms to consider.
• Small funds offer greater diversification than the biggest funds, which often have to take large bets in the most liquid markets to generate returns.
• In terms of talent retention, while smaller funds may struggle to compete in terms of the compensation packages offered, they can provide better opportunities for career advancement and learning.
Giants under threat?
There certainly appears to be growing scepticism about the ability of the largest funds to deliver value. The giant multi-strategy and multi-manager hedge funds have very high costs (often because of the talent wars they engage in ), leading some investors to question the wisdom of investing in these funds when 10-year US Treasuries are yielding around 4.5%. Bloomberg, for example, reported in 2024 that clients received only 41 cents of every $1 made last year by multi-strategy funds that passed on all their costs to investors via fees and other charges. Investors are also required to lock in their capital for up to five years in some cases.3
Meanwhile, the data on emerging managers shows that ‘across almost all alternative asset classes new and smaller funds tend to outperform’, according to the publication Chief Investment Officer.4 It says this is because some funds are pursuing unique strategies, but many outperform simply because they are able to take advantage of opportunities at the small end of the market that have greater upside potential.
Download our state of the hedge fund industry report
As part of our aim to be at the forefront of the hedge fund industry, IG Prime commissioned a survey into the attitudes of hedge funds and institutional investors to key issues facing the industry in 2024 and 2025. The results help inform our State of the Hedge Fund Industry 2025 report. The first of a forward-looking annual series, this year’s report seeks to explain why the industry may have reached a turning point, with returns and asset growth set to improve – possibly markedly – in the coming years. Click here to download the full report now.
Sources
1 https://www.aima.org/compass/insights/emerging-hedge-funds/standing-strong.html?
2 https://www.hfr.com/media/market-commentary/hedge-fund-assets-increase-to-fourth-consecutive-quarterly-record-as-election-geopolitical-risks-surge/
3 https://www.bloomberg.com/news/articles/2024-03-05/hedge-fund-startups-on-the-rise-with-pricey-multistrategy-giants-under-scrutiny
4 https://www.ai-cio.com/news/as-mega-alts-funds-appear-emerging-managers-face-bigger-hurdles/
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