Starting A Hedge Fund Is Getting Next To Impossible
Citi just released a 45-page report on the hedge fund industry in the United States (where there are more hedge funds than Taco Bells), and it looks like barriers to entry are higher than ever before.
Citi determined that, with costs as they are, it takes an emerging hedge fund manager at least $300 million AUM just to break even. Basically, if you have less than $1 billion, you shouldn't even get out of bed.
The biggest cost of all the monster costs is compensation for the compliance personnel that keep you straight with the Feds. Size is a huge advantage there too.
From Citi:
For small hedge funds with only $100 million AUM, compensation accounted for 8.7 basis points ($87,000) out of total expenses of 17.7 basis points ($177,000)-49% of total compliance expense...
Overall dollar-based costs of compliance rise only modestly, from $177,000 to $210,000 as hedge funds move from $100 million to $500 million AUM, but the composition of those costs is quite different. Expenditures on software and other third-party services shrinks from 51% to only 23% of compliance spend. This share continues to decline at every progressive AUM level within the institutional category, falling to only 6% for firms with $10.0 billion AUM.
All that's not even the worst part. What really might get kids to go back to dreaming of being astronauts instead of hedge fund managers is that management fees are collapsing.
Unless you're a rock star hedge fund manager, clients will not pay you the infamous "2% and 20%" hedge fund compensation scheme. Here's what Citi has to say about compensation for hedge funds with $5 billion AUM or less:
Average management fees continue well below the historical 2.0% level, ranging from 1.58% to highs
of only 1.76% for the largest firms in this band. Management company expenses dip and stabilize,
ranging from 63 to 68 basis points. No appreciable economies of scale are realized by firms in the institutional category, as this is a period of ongoing investment into upgrading the firms' capabilities
and expanding their teams. During this phase of growth, headcount grows by ~2.0x for every ~3.0x
increase in AUM.
So what's the solution if you still want to be an investor? Franchising. Big shops with hedge funds within them. Citi found that firms that fit this description have an average AUM of $36.4 billion, and that only about 53% of their business is focused on the hedge fund.
Or you could just be David Tepper from day one. That's the other solution.