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The talk of the town in alternative investment circles in the past week has certainly been around the legal ‘win’ that a group of trade associations enjoyed on behalf of their members – and the broader alternative investment industry – that ‘vacated’ the Securities and Exchange Commission’s private funds rule that was originally announced in August last year.
Those rules have likely impacted the hedge fund launches space in the past 10 months. Not only would the regulatory burden have been higher – and more costly – for new launches, but the preferential treatment rule around investor terms also made it difficult for some managers to provide confidentiality to certain investors, particularly when a seed investment was involved.
Initially, it seemed that new launches weren’t put off too much by the news. Back in December last year, HFR said that new hedge fund launches in the third quarter of 2023 were down, but not significantly.
But then they were also down in the fourth quarter of 2023 as well. And that’s partly a surprise because the current macroeconomic environment is largely more conducive to new hedge fund launches, as opportunities across asset classes to generate alpha is higher due to a less predictable geopolitical environment – both the US and the UK, for example, have national elections this year, and France just announced that it would hold presidential elections in a surprise move.
Indeed, there is much to be positive about in hedge fund land at the moment in terms of performance. Hedge funds have not had a bad first five months of 2024. HFR also publishes a monthly update, and the HFRI Fund Weighted Composite Index is up +5.03% through the end of May. Their rolling, 1 year return is now +12.19% after posting a 2023 calendar return of +7.5%.
I can’t predict whether the new launches data for Q2 will be up, down, or roughly the same. But I do think that the second half will see more activity now that the regulatory regime seems to be clearer – or, at least, it does for now. The SEC might appeal the decision, of course. And other headwinds are emerging – a group of large and influential allocators and investment consultants signed an open letter at the end of May advocating for “the implementation of cash hurdles in incentive fee arrangements across the hedge fund industry.”
It is true that most of the signatories are large, established allocators, which will typically not look at an emerging manager – not every hedge fund start up raises the sums that Jain Global seemingly is, of course. Most raise friends and family money first, then look to the fund of funds market to grow. But some investors will take the lead of these large allocators, making some hedge funds question whether it’s worth the risk of a cash hurdle, especially when they are small and new.
Still, one of the common personality traits among new hedge fund launches that we work with at EFSI is a formidable belief in the manager’s ability to deliver alpha returns. So, in my view, the net impact of the suddenly less aggressive regulatory outlook versus the cash hurdle conversation is positive in terms of new launches.
Time will tell if I’m right, of course. But with rates higher for longer, and uncertainty in both geopolitics and macroeconomics, there’s no time like the present for new hedge funds to get out there and deploy capital.