The tide has gone out for hedge funds. Many have indicated that they "feel" X% of the hedge fund industry will go under. Perhaps a little data and a crude stab at a model will improve a rather dire debating point. The term hedge fund basically means anyone who believes they can manage money and get away with justifying a 1-2% management fee and 15-44% performance fee, it has become more compensation class than asset class and has been for years for many. True sustainable alpha is rare. Here are some rough estimates and stats, please inform me of changes or errors:
- Estimated 9-11,000 funds as of 2008
- Estimated average annual return for 2008 -18%
- Median AUM (assets under management) of $80m
Using these crude figures and a little back of the envelope calculating we can come to the conclusion that there will be >20% hedge fund closures in the next year. My own guess is closer to 40% or 6,600 left standing close of business 2009.
It is mostly the little guys who are going to be squeezed out. Many funds large and small shouldn't have been there in the first place. Although, I haven't seen the data, my guess is that Fund size in terms of AUM follows a simple power law distribution.
If we assume the median fund has $80m under management we can model the situation going forward. Please note that $100m AUM is the magic level where pension funds etc. used to have a sniff at you about doling out an allocation and other such heady acts of a bygone era.
Most fund companies are small cottage funds with an average staff of 4 professionals, that equates to more than 20%x11,000x4 roughly 8,800 hedgies looking for jobs soon, not including support staff. If we assume the average fund in the past had 5 professionals x 11,000 funds, then the industry supported 55,000 Sr. roles.
Assuming a 5% natural turnover within fund companies that equates to 2,750 open position in a non-growth year. With shrinkage of 20% that means maybe 2,200 open positions available in 2009. Assuming no external talent enters the competition for a role, a laid off hedgie has a 1 in 4 chance of finding a new role back in the business.
A simple operating model for a small hedge fund with $80m AUM may look like the table to the left. Spreadsheet available Download Hedgefundblowupometer
Of course each fund is a different animal with lower or higher costs, staff count etc. Please note the base salary for the median hedge fund trader is far from stratospheric in a poor year. I shall refrain from comment in regards to Sr. bankers and other socialist ilk who receive bailout bonuses or collect checks from weak kneed compensation committees at the board bored level.
The important lesson here is that during a recession, a positive feedback mechanism makes it more difficult to find a job. The number of available jobs shrinks at the same time those with experience and skills on the market expands. This multiplier effect in a single industry is dangerous especially one that was falsely puffed up on 5-10% credit and ridiculous leverage in some instances. Spread across an economy this feedback is downright debilitating. GD 2.0.