The Coming Hedge-Fund Merger Wave

Date: Thursday, May 3, 2012
Author: Brendan Conway, Barron's

Hedge-fund marketing leads to mergers and consolidation: That’s the short version of the argument voiced this week by Larry Tabb, founder and chief executive of the Tabb Group. And smaller hedge funds, the ones some voices are predicting will benefit the most from advertising, could be left out in the cold.

Recall that the Jumpstart Our Business Startups Act, or “JOBS Act,” has a provision that could open up hedge-fund marketing for the first time.  With the caveat that there are reasons to thinkthe SEC may still choose to scale back this provision, this is a big change barreling down the pipe. President Obama has already signed the bill. What’s left is how regulators interpret it.

Tabb argues over at Advanced Trading that the drive to advertise is a result of the desire to gather more assets. Hence, advertising sets off a chain of events that results in eager funds snatching up smaller ones, and the smallest funds being left behind:

As funds start to advertise, they will move from manufacturers to distributors. Why does someone advertise? To attract more assets. And so it begins: The industry migrates from a focus on return to a focus on asset accumulation. And this will cause consolidation.

Traditional asset managers that currently advertise will be attracted to vehicles they can now promote. Larger hedge funds and public fund companies will be able to use their capital to attract more assets, and the smaller funds will increasingly be marginalized. How many mutual fund companies do you see with under $1 billion in assets? Now tie this into the need for managers to be relevant, consolidating flow, increasing regulatory burdens, and, from the traditional fund perspective, business model compression from increased ETF competition, and it doesn’t take much of a leap till you begin to see that larger traditional funds will move in, accumulate assets and use their size to acquire smaller and more talented managers, who will have a harder time surviving on their own.

While this won’t happen overnight, given the JOBS Act’s implementation timeframe, we should see this begin to play out over the next few years. That is, unless the pumpers and dumpers quickly kill the goose that lays the golden egg and Congress reacts by killing the program dead in its tracks.