If you want to work in finance, you might well want to work in a hedge fund. Many view hedge funds as the pinnacle of a finance career. However, the hedge fund sector has changed.
Hedge funds have many problems at the moment, but the single biggest challenge is returns. In aggregate, performance across the sector has been dreadful. Ten years ago investors wouldn’t think twice about paying ‘2 and 20’. Now, with performance across the sector so lacklustre, a privileged few funds continue to charge that and even fewer new launches are able to command these fees. This has put a lot of pressure on hedge fund revenues.
Fee pressure is compounded by increasingly concentrated fund flows. Since the financial crisis, funds have been funnelled to the largest and most established players. Asset allocators have been on the defensive, focussing on job preservation. Who can blame them?
While this attitude clearly favours larger funds, it also has implications not just for market share but also for the costs of running a smaller fund. Asset allocators today come armed with lengthy due diligence questionnaires for the funds they invest in. They expect greater disclosure on the drivers of portfolio performance and underlying exposures than in yesteryear. This is fair but expensive to service; either funds spend money on expensive analytical tools or you invest the time building the capability and doing it yourself.
All of this means that the minimum efficient scale for hedge funds has risen dramatically and continues to rise. Large amounts of capital are needed to get off the ground. It used to be possible to have a profitable fund with tens of millions under management. However, in today’s environment with the fee pressure and cost of client service both having gone the wrong direction, oftentimes even $200m won’t pay the bills when you need a large team and many investors pay half the fees they used to.
The market environment is also making the job tough. Central bank policy and prose drives markets to a greater degree than ever before. This doesn’t just affect portfolio management; this also drives investor behaviour. Asset allocators are increasingly adopting active top-down allocation strategies. Fund investors are reacting – and expecting fund managers to react – to central bank policy shifts and tweaks, regardless of whether this forms part of their investment strategy. If the manager doesn’t do it, the investor will do it for them.
With hedge fund returns so poor, investors increasingly adopt the job of a hedge fund manager themselves. They often have strong opinions about what managers should be doing with their money.
These asset allocators can also effectively insource some of the hedge fund manager’s role by using tools like ETFs which allow them to react quickly to market moves. We live in an age where information is readily available to everyone. These days everyone has a Reuters or Bloomberg app on their phone. Whether or not these allocators are able to add value by timing markets or picking stocks themselves is moot. If they believe they can, they can just go and do it given the tools to do so are now readily available. Frankly, who is to dispute their ability to do the job when hedge fund returns have been so poor?
Large hedge funds have gained market share, but this isn’t necessarily because they are performing better. Many are discounting their products to a very low margin and providing investors with superior risk analytics and portfolio disclosure. The marginal cost to service new assets under management is close to zero, so even low fee assets still add to the bottom line for the big players.
Large asset management houses have the scale to employ salespeople and can afford to explore new strategies – things it is very difficult to do in a small fund management business.
In summary: nothing about running a hedge fund business today is easy. There is pressure on top line. There is pressure on costs. Client service is becoming more onerous. There is pressure from regulators. Hedge funds are just in a difficult place right now.
As such, I’m changing sector. I’m starting a business in the health and fitness industry where I think the environment is a lot more favourable, where we can genuinely innovate and can make good returns. I have co-founded a business called Digme Fitness running pay-to-play fitness studios: “Richmond, Oxford and a third site in the City to be announced shortly.”
Health and fitness is something I am passionate about as an amateur Ironman athlete, it’s a growth area and the gym market is in need of innovation. The existing operators are sleepy, run bloated structures and are slow to adopt technology.
I’ve already been struck by how much less bureaucratic this sector is than running a business in finance. Of course, we have regulation to deal with – but far less. And the sums of money required are wildly different. Rather than counting what you need in the hundreds of millions, we now count in the hundreds of thousands. It’s orders of magnitude different, doesn’t carry the pressure of a mark-to-market P&L and offers investors far better tax benefits than investing in a fund.
Would I go back to hedge funds? Never say never, but things would need to be different. I’d like the competitive dynamics to be a lot more favourable to smaller operators. I’d like markets to feel healthier than they do right now. Most importantly though, I’m really excited about the opportunity that I see in the health & fitness market and this is where I see the opportunity to create the most value for me and my investors in the foreseeable future.
Geoff Bamber is CEO at Digme Fitness. He previously spent six years as chief investment officer at Skyline Capital Management, a London-based global long/short equity hedge fund.