Citi survey suggests hedge fund struggles
30 January 2015 New York
Image: Shutterstock
The hedge fund industry could see about a 30 percent dip in profits in 2014 compared to 2013, due to poor performance throughout the year, according to Citi’s annual hedge fund industry operating metrics survey.
Hedge fund industry profits reached $31.2 billion in 2013, but these figures dropped by 30 percent to $21.9 billion in 2014.
The estimated figures take in to account the institutionalisation of the hedge fund investor base, which shifts profit ratios in the industry. Now, profits from management fees are equal to those from performance fee revenues in 2013 and previous years, when managers had to meet institutional targets of 10 percent annual returns.
The report was based on proprietary analysis from 149 hedge fund firms that represent $581 billion in assets under management (AUM) in the industry, and 18.8 percent of total industry assets.
Sandy Kaul, global head of business advisory services at Citi, said: “Management fee revenues have become an increasingly important part of the industry’s profit base in recent years.”
“Lower institutional return targets and concerns about excessive volatility make it more difficult for managers to earn outsized performance fees. With AUM at record highs, profits from management fee revenues now account for a larger share of total profits, coming in at nearly two-and-a-half times performance fee profits in years when performance is down such as in 2014.”
The survey highlighted the importance of hedge funds to the asset management industry, with Citi citing the Boston Consulting Group’s industry-wide estimates alongside their own findings.
According to the data, in 2013 the $31.2 billion that hedge funds saw in profits accounted for 34 percent of the total asset management industry profits, but only 4 percent of the estimate of total AUM in the asset management industry.
In 2013, the average hedge fund operating margins from management company fee revenues was 67 basis points, compared to 12 basis points for the asset management industry overall. For 2014, this increased by about 10 percent to 74 basis points.
Smaller hedge funds are thought to be hit harder with regards to profitability. Those with average AUM of under $100 million, and with individual asset funds of up to $350 million, saw an average improvement in operating margins of 17 basis points.
Firms in this band may struggle to cover their operating costs based on the management fee collections. In 2013, the deficit in operating margin of 86 basis points, which fell to 69 points in 2014. In practice, this meant that costs to be covered fell from $330 million in 2013 to $310 million in 2014.
Kaul said: “These organisations were able to use their performance fee profits in 2013 to cover their management fee operating shortfalls, but as a group, these funds simply did not generate enough performance fee revenues in 2014 to cover their gap.”
“We see a $615 million industry-wide shortfall across this tier of firms and this is likely to result in more closures of small hedge funds.”
Despite the 30 percent predicted drop in profits, the Citi survey found that theoretical equity value is only down 7 percent.
This is explained by Citi’s industry approach of counting profits from management fees at four times the profits from performance fees. Using this method, the total theoretical equity value of the hedge fund industry for is $239 billion, down from $257 billion in 2013.
The number that a company’s fee profits is multiplied by is based on the diversity of their product mix and investor base. This leads to the greater product expansion across larger firms.
Of the survey respondents with assets of around10 billion AUM, typically had about 83 percent of assets in a core hedge fund project. In contrast, those with around $31 billion in AUM had 35 percent of assets in that category, and 36 percent of assets in publicly traded long-only or liquid alternative assets.
Kaul concluded: “For large hedge fund firms, having a mix of privately traded and publicly traded funds helps support higher firm valuations in all our scenarios except when hedge fund performance is at 10% or better.”
Hedge fund industry profits reached $31.2 billion in 2013, but these figures dropped by 30 percent to $21.9 billion in 2014.
The estimated figures take in to account the institutionalisation of the hedge fund investor base, which shifts profit ratios in the industry. Now, profits from management fees are equal to those from performance fee revenues in 2013 and previous years, when managers had to meet institutional targets of 10 percent annual returns.
The report was based on proprietary analysis from 149 hedge fund firms that represent $581 billion in assets under management (AUM) in the industry, and 18.8 percent of total industry assets.
Sandy Kaul, global head of business advisory services at Citi, said: “Management fee revenues have become an increasingly important part of the industry’s profit base in recent years.”
“Lower institutional return targets and concerns about excessive volatility make it more difficult for managers to earn outsized performance fees. With AUM at record highs, profits from management fee revenues now account for a larger share of total profits, coming in at nearly two-and-a-half times performance fee profits in years when performance is down such as in 2014.”
The survey highlighted the importance of hedge funds to the asset management industry, with Citi citing the Boston Consulting Group’s industry-wide estimates alongside their own findings.
According to the data, in 2013 the $31.2 billion that hedge funds saw in profits accounted for 34 percent of the total asset management industry profits, but only 4 percent of the estimate of total AUM in the asset management industry.
In 2013, the average hedge fund operating margins from management company fee revenues was 67 basis points, compared to 12 basis points for the asset management industry overall. For 2014, this increased by about 10 percent to 74 basis points.
Smaller hedge funds are thought to be hit harder with regards to profitability. Those with average AUM of under $100 million, and with individual asset funds of up to $350 million, saw an average improvement in operating margins of 17 basis points.
Firms in this band may struggle to cover their operating costs based on the management fee collections. In 2013, the deficit in operating margin of 86 basis points, which fell to 69 points in 2014. In practice, this meant that costs to be covered fell from $330 million in 2013 to $310 million in 2014.
Kaul said: “These organisations were able to use their performance fee profits in 2013 to cover their management fee operating shortfalls, but as a group, these funds simply did not generate enough performance fee revenues in 2014 to cover their gap.”
“We see a $615 million industry-wide shortfall across this tier of firms and this is likely to result in more closures of small hedge funds.”
Despite the 30 percent predicted drop in profits, the Citi survey found that theoretical equity value is only down 7 percent.
This is explained by Citi’s industry approach of counting profits from management fees at four times the profits from performance fees. Using this method, the total theoretical equity value of the hedge fund industry for is $239 billion, down from $257 billion in 2013.
The number that a company’s fee profits is multiplied by is based on the diversity of their product mix and investor base. This leads to the greater product expansion across larger firms.
Of the survey respondents with assets of around10 billion AUM, typically had about 83 percent of assets in a core hedge fund project. In contrast, those with around $31 billion in AUM had 35 percent of assets in that category, and 36 percent of assets in publicly traded long-only or liquid alternative assets.
Kaul concluded: “For large hedge fund firms, having a mix of privately traded and publicly traded funds helps support higher firm valuations in all our scenarios except when hedge fund performance is at 10% or better.”
NO FEE, NO RISK
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
