By Simon Kerr
A recent article suggested that SWFs are exploring the possibility of buying asset management companies. Could hedge fund management companies be on their radar? The reasons given for buying asset managers are two-fold: to reduce fees and to ramp up investment expertise.
It could be that the most senior executives at the SWFs have inwardly digested the premise of Simon Lack’s book, “The Hedge Fund Mirage”. The story is that hedge fund managers take most of the money that hedge funds make. According to Lack “there’s no getting away from the fact that fees have taken anywhere from most to more than all of the “real” profits that hedge funds generate (that is, in excess of the risk-free rate).” The argument is unlikely to have been accepted wholesale by SWF staff, otherwise their funds would not be amongst the largest net purchasers of hedge funds over the last year.
In addition, there is clear survey evidence that there is a growing proportion of hedge funds that have had to accept lower fees for larger mandates. Plus, of all types of investors SWFs are the most likely to 0btain fee breaks because of the their scale and long investment horizon. That is, SWFs do not have to go through the expense and difficulty of purchasing hedge fund management companies to fulfill the objective of reducing the fees they have to pay.
On the second reason for SWFs to buy hedge fund management companies, it is true that SWFs are ramping up their investment expertise generally and in relation to hedge funds specifically. But that does not have to be achieved by the acquisition of a hedge fund management company. And in any event the culture class between quasi-civil service SWF staffers and the owners of hedge fund management companies would be a case study for business schools looking at how acquisitions destroy value. That written, where a broad asset management company has solved the problems of running hedge fund and long-only assets next to one another there could be a case for acquisition of an established money manager by a SWF, but not for a dedicated hedge fund manager.
There is a view in asset management M&A that a significant proportion of the potential value in an acquisition has to come from future growth rather than just cost cutting – beyond the Aberdeen Asset Management approach, if you like. Pakenham Partners specialises in asset management M&A, and director Kevin Pakenham sees that a SWF deal for a hedge fund management company could be characterised as as a sort of seeding arrangement – a capital commitment to the underlying hedge fund would come with a takeover, but the kicker in the deal to the SWF would be future asset accumulation from third parties. He says, “This sort of seeding is a branch of venture capital. It would not be good practice for a SWF to do it because it would not help fulfill the principal aim of SWFs which is long-term value protection. SWFs need good performance like other investors, and they need to be able to fire the managers that don’t produce it. Investing with an in-house hedge fund would make that difficult.”