Too-Big-To-Invest Problem

Chidem Kurdas

Back in the day when hedge funds managed more then $2 trillion, nearly half of the capital was channeled via funds of funds.  Current assets are still well below that – even with post-crisis recovery – and funds-of-funds assets are a significantly smaller fraction of the total. There are fewer funds of funds around and a small number of very large ones dominate the market.

 As a result of these developments, hedge funds have fewer investors. And some of those investors find themselves with a problem: they account for too much of the capital of the funds they’re in. Their investment may be no larger than before, but because the pond has shrunk, they’re now relatively big fish.

That can violate their rule of not having more than a certain level of exposure to a single manager. It can create more risk. Even if it does not go over the exposure limit, there are other complications.

Funds of funds with more than 5% of the assets of an underlying fund may have to legally treat that fund manager as an affiliate. Then that runs into clients’ conflict of interest rules against investing with affiliates.

“There are worse problems than this,” says one investor. “But it does complicate decisions.”


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