Lehman, Merrill woe will be great news for big hedge funds, not so good for small hedge funds

Date: Tuesday, September 16, 2008
Author: Efinancialnews.com

This will cut into all hedge funds' profitability in the short term.

Small hedge fund managers will be most hurt by this, as their profit margins, in dollar terms, are the slimmest. Bankers will also impose the most stringent terms on them because they generate less business for banks than large hedge funds. Under these conditions, combined with net outflows from investors, David Smith, chief investment director of multi-manager business at Swiss-owned GAM, said: "I think you will see an awful shakeout of the smaller hedge fund managers, many of them will prove not to be economically viable.”

In the long-term, this will help the largest hedge fund managers, in three ways.

First, the disappearance of a tail of small managers will clear out competition. Hedge funds have found themselves crowded together in the same positions in the last four years, notably convertible arbitrage managers who came to comprise more than 70% of the convertible bond markets in 2004, according to Watson Wyatt; statistical arbitrage managers, whose computers led them to take positions in the same equities and try to leave them at the same time in early August last year; and managers in Asian equities. Fewer players will bring a welcome relief.

Secondly, a wave of talented hedge fund managers currently locked into their own, small businesses will suddenly become available to be recruited by the large firms.