TABB Study: Hedge Fund Consolidation to Increase

February 15, 2005 ( - The hedge fund industry will see an increasing amount of consolidation and an even stronger call for increased yield over the next five years, according to a TABB group report.

Citing the rush of cash into the marketplace and an increased pressure to strengthen yields, the TABB report asserted that the hedge fund industry is in a transition period. One effect of this transition: a consolidation of funds.

The TABB report indicated that although large funds will probably not buy smaller funds en masse in the coming years, it is likely that funds of funds and traditional asset managers will start to purchase smaller hedge funds in order to fend of threats from larger funds.

Another effect of the transition: a call for higher yields on investment. “This battle for yield will have a serious significant impact on the industry,” wrote Josh Galper, director at TABB Group and author of the 61-page report, in a press release. “Initially, it will force funds to change their overall investment strategies, invest in new analytics to more aggressively look for opportunities and focus on reducing costs…which for many large funds will be fairly new in a burgeoning industry more return-focused than cost-focused.”

The survey also looked at other aspects of the hedge fund universe. One such focus was on the trading technology of firms. Forty-seven percent of firms currently execute trades through low- or no-touch channels, such as direct market access, algorithms, and crossing networks. Fifty-three percent, however, execute trades via older methods, such as the phone. However, low- or no-touch methods will become increasingly common, with 57% of hedge funds expecting to use such technology by 2007.

Prime brokerage was also a focus of the survey. Goldman Sachs and Morgan Stanley are the two kingpins of this space, holding a 40% market share between the two of them, the survey revealed. Prime brokers such as these have a steady influence in a hedge fund’s inner workings, the survey also found, with 50% of funds reporting that their broker relationship determines what algorithms they use.

Nearly 40% of hedge funds surveyed are increasing their broker relationships, often citing research, product diversity and improved trading technology as reasons to do so. Only 20% are reducing their broker relationships, with most of these citing the need to consolidate their execution platform as a reason.

On the topic of regulation, 69% said that they believe such a move is a positive step for the industry. However, among larger funds, only 50% take this view.

The survey is the result of interviews with senior management at 63 hedge funds across multiple asset classes and sizes collectively managing $110 billion, 11.8% of the $930 billion hedge fund industry. To get an executive summary of the survey, please see .