For this quarter’s capital introduction update, we decided to address an issue many new managers are facing – fundraising in the current environment.
There has been a lot of discussion about the difficulty newer managers are currently facing in fundraising at launch and shortly thereafter. For many new hedge fund managers, asset under management levels at launch have come in below expectations and growth in those levels has been slower than anticipated.
While there are numerous reasons why new launches can be less successful than expected (fierce competition, decreased risk appetite of investors, etc.), one major reason is the lower level of overall liquidity in the portfolios of institutional investors.
Investors have noted the lack of liquidity in their portfolios, as private investments have had low distribution levels in recent years. Institutions may have also increased their commitments to private investments, including private credit, so a greater percentage of their portfolios are in illiquid investments. As a result, many portfolios are at or above their target allocations to private investments.
Institutional memories among investment office professionals and investment committee members are long enough to remember how illiquid portfolios became during the Global Financial Crisis. Many institutional investors pay more attention to stress tests and have put in stricter liquidity requirements as a result.
So what does this decreased level of portfolio liquidity mean for newer hedge fund managers? The lower level of liquidity prevents institutional investors from having available cash to invest with new managers – especially those that may have initial lock-ups of one year or longer.
Every decision to invest in a new manager is not made in a vacuum; investors need to decide from where those assets will come. Few institutional investors hold a significant amount of dry powder or cash just waiting to be deployed to new ideas. Redeeming from existing hedge fund managers with quarterly liquidity in favor of new ones with initial lock-ups would be typical in a normal environment, but it makes for a more difficult discussion when a portfolio is nearing its liquidity guardrails. And more liquid investment sources like equities, bonds, and cash still need to be available to fund spending requirements and capital calls.
The good news is that there have been numerous surveys published recently saying that investors are looking to add to their hedge fund allocations. That lines up with what we are hearing from investors as well. With the U.S. equity market at or near its all-time high, investors are seeking to find less market-correlated returns and long/short equity managers who can add value and/or provide relative protection in choppy environments. A bout of market volatility would likely spur additional interest in hedge funds who perform well when equity markets pull back.
Avoiding a sustained and sharp pullback like we saw in the Global Financial Crisis is key. Assuming we do and start to see more distributions from private investments, we believe that hedge fund managers, especially new launches, will benefit from this increased portfolio liquidity.
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