Agecroft sees tailwinds for small and mid-sized hedge funds in 2011

Reduced competition from large hedge funds and fewer investors on the sidelines should help small and mid-sized managers capture a greater share of inflows in 2011, according to Agecroft Partners.

Hedge fund assets grew to $1.77 trillion in the third quarter of 2011, close to their pre-crisis peak of $1.9 trillion, according to Hedge Fund Research. However, almost 75% of new capital raised during this period went to hedge funds with more than $5 billion in assets, leaving smaller funds struggling to grow.

"2009 and 2010 were devastating for small and medium-sized hedge funds. Even though these managers represent 95% of the number of hedge funds, they were only able to attract a small fraction of new hedge fund allocations," said Don Steinbrugge, chairman of marketing specialist Agecroft Partners.

Steinbrugge believes "a much larger percentage of assets will flow to small and mid-sized managers" in 2011. He attributes this to "less competition from the large, well-known hedge fund managers, as well as increased allocations from endowments, foundations and hedge fund of funds".

The largest hedge funds were raising capital aggressively in 2009 and 2010 as they sought to replace funds lost in the aftermath of the financial crisis. "After two years of the majority of assets flowing to the largest hedge funds combined with strong performance, many of these big funds have either closed or are near capacity," said Steinbrugge.

Foundations and endowments are also coming back into the market after sitting on the sidelines for the past two years, Steinbrugge said. "This will especially benefit mid-sized hedge funds as these sophisticated investors tend to have a bias against the largest hedge funds."

Steinbrugge also believes funds of hedge funds (FoHFs) will focus more on smaller managers and niche strategies in 2011. Institutional investors have been increasing direct allocations to well-known hedge funds or gaining exposure to these managers through a single investment in a large FoHF, he said. This is creating more demand for FoHFs which focus on smaller managers that do not overlap with other parts of the institutional investor's portfolio.

Agecroft expects to see increased allocations across all segments of the hedge fund industry in 2011 with small and mid-size funds capturing a noticeably larger share of overall inflows.

Steinbrugge also predicted that 2011 will be "the best year for hedge fund launches since 2007" with "multiple billion-dollar hedge fund launches" as financial institutions spin off their proprietary trading desks.

Agecroft's projections are based on several dominant and emerging trends identified through conversations with more than 300 hedge fund organisations and 1,500 institutional investors during 2010.