Hedge Fund Armada

A Hedge Fund Armada is the term used to refer to a multi-billion dollar hedge fund, or smaller fund, that has gotten too large to efficiently manage its assets based on factors such as the strategy, poor trading ability, not enough staff and lack of a hedging strategy to protect its investors in down markets.

It would seem that these large multi-billion dollar funds, that have become Hedge Fund Armadas, were simply trying to preserve their assets under management. “Growth for growth’s sake” has its place in business, but it can be a dangerous game when applied to the hedge fund industry. When a fund manager makes a 2% management fee on its assets under management, it’s simple math, the more money under management the more money the manager makes on its 2% management fee. As long as his or her returns keep pace with the rest on his or her hedge fund peers in their strategy category, then the investors in that hedge fund have no reason to withdraw their investment.

Some managers do understand the risk of getting too large and when they feel they have hit a maximum amount of assets they feel comfortable managing, they close the fund to new managers.They would rather have strong returns than under perform on a larger asset base.

There are a few exceptions to the Hedge Fund Armada syndrome however, like James H. Simons, a former math professor who runs Renaissance Technologies, John A. Paulson who runs Paulson & Co., Inc. and John Arnold, founder of Centaurus Energy. These managers have proven they can successfully manage a multi-billion dollar fund.

In the future it is likely that institutional investors, pensions and fund of funds will diversify their investments with more managers rather than a few select managers. Diversification has always been a wise investment principle and diversification among hedge fund managers is just as important.

Likewise,Hedge Fund Formation will increase as Hedge Fund Armadas unwind. The same is true of what is happening on Wall Street after the Bear Stearns and Lehman Brothers debacles. Asset formation is looking is regrouping and the smaller more nimble boutique firms are starting to pop up. For those that have a “glass half full” mentality, now has never been a better time to set up an investment banking firm or hedge fund.

Joseph B. LaRocco