Will Small Firms Survive?

Chidem Kurdas

Costs are up. Allocations are slow. What’s an emerging manager to do? The talk was about pressures and priorities at a conference organized by the New York State Society of Certified Public Accountants.  

Client due diligence is longer and tougher, firms need more staff to deal with it and this increases the cost to the manager, says Chris Mears of Rothstein Kass. 

New firms have to survive longer with higher costs but little assets. Investor allocations take a lot longer, Greg Farrington of Constellation Investment Consulting said. The lead time is around 18 months, up from nine months several years ago, he finds.  

Emerging managers bring new talent, crucial for the industry’s success. Leon Metzger, a hedge fund veteran and lecturer at Yale University, pointed out that on the whole smaller funds outperform larger funds, yet most money goes to larger funds. 

Institutional investors work with consultants who are worried about headline risk, he said.  Large firms have more controls because there is more money for staff so that separate functions are handled by different people. Seeking safety, institutions avoid small, new funds. 

Certain staff positions are particularly important. John Myklusch of Trilogy Advisors said that if a small fund needs to prioritize, he would want another person who can do portfolio valuation so that it’s not the manager alone who is responsible for valuation. 

Increased regulation means increased cost of doing business, which weighs more heavily on smaller and newer firms because they have less assets to carry regulatory expenses. Managers with more than $150 million in assets will have to register with the Securities and Exchange Commission and meet new requirements, as mandated by the Dodd-Frank Act. Funds below that threshold may have to register with a state, depending on where they’re located.

Beth Manzi of PEF Services has been trying to find ways for a small fund to do compliance less expensively. 

A number of speakers at the NYSSCPA meeting emphasized that customers, rather than regulators, are driving the trend toward greater resource requirements to run a fund business.  Funds are chasing the same dollars and have to be in line with what investors want, Mr. Mears said. Managers put in  more resources to appease investors, said Mr. Farrington. 

The question for many new managers with strong performance is whether they can get to the first billion in assets. Investors preferred very large, well-known fund firms in the aftermath of the crisis but  may now be more willing to go for mid-size firms.  A survey a couple months ago by Citi Prime Finance suggests that the new sweet spot for institutions is in the $2 billion to $5 billion asset range.

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