The "Mega Funds" of tomorrow will look less like the multi-billion dollar, multi-strategy Hedge Funds of today and more like a combination of a proprietary trading group at a large investment bank and a large traditional long only Investment Management firm.  Rather than these “Mega Funds” consisting of only one large multi-strategy fund, these firms will consist of many separate single strategy funds as well as a few funds which are “multi-strategy.” An example of a fund presently participating in this transformation is Citadel Investment Group.

This separation of strategy and funds will allow the investor to choose which products to put into their portfolio.  The benefit of this choice is that it allows investors to not experience the negative returns which may come from a strategy that the investor would prefer to not be involved with; but in the past had to be accept due to the firms’ structure as a single multi-strategy product. For many institutional investors this separation of investment strategies also eliminates the conflicts of interest and allows the investors to stay within their predetermined investment guidelines, in the past these investment guidelines may have not allowed the investor to invest in the fund. I believe this separation of strategies will be appreciated by institutional investors, especially if the “Mega Funds” ensure that strong portfolio managers are hired for each separate strategy portfolio.

Risk Management and Business/Strategy Management

This separation provides the “Mega Fund” with an additional risk management and strategy/business management perspective.  The risk management component is based on the firm’s ability to better monitor investments within each of these funds and to hopefully have more efficient reporting systems in place to assure that not only the individual fund’s risk guidelines are maintained, but the overall firm’s risk guidelines as well.  Additionally, this separation of strategies offers the “Mega Fund” a better business risk model because the fund has numerous strategies to market; and when one strategy is in demand it can be aggressively marketed to present and prospective clients.  At the same time another strategy, which is in less demand by the investor class, can be sustained while not creating a negative impact to the “Mega Funds” bottom-line, unless the strategy itself fails.  Preserving this fund enables the “Mega Fund” the ability to bring this product to market the moment it gains favor with the investor class again.

Mega Fund Infrastructure

As discussed in “The Creation of the Mega Fund,” these new Mega firms will offer their clients access to numerous strategies with well defined infrastructures in place which can support the firm and its assets. These firms will spend heavily on technology, operations, and accounting to ensure that their infrastructure is top notch.  And although most of this spending will happen while these firms are still small, $5-40 billion under management, the costs can be recuperated very quickly as these firms grow and are able to bring on new strategies and clients with significant ease.  

These “Mega Funds” will have their own administrator groups, operations and accounting divisions, talent acquisition teams, and marketing teams.  These teams/groups will service all of the funds which fall under the umbrella of products supported by the “Mega Fund.”  Furthermore, the “Mega Fund” will have a large trading and research division which will support and provide invaluable knowledge to all of the strategy specific portfolio management teams.  Some of these “Mega Funds” will still rely partially on the “The Street” for research and trade execution, but the majority of these funds will build-out large in-house research and trading capabilities.  This build-out ensures that the fund’s interest and the interest of their investors are aligned.

A “Mega Fund” will have two parts to every investment team; the strategy specific professionals, and the fund generalist analysts.  The fund generalist’s analysts will not be a generalist in their research focus, but rather will be utilized by all investments teams and specialize in one or two sectors.  It will be their responsibility to provide company specific information to the actual investment strategy team which could consist of a sole PM, a team of PM’s, or a combination team of PM’s and Analysts depending on each group. It would then be the responsibility of these teams to use this information in what ever manner was beneficial to their specific strategy performance.  These fund generalist analysts would be viewed as “experts” in their specific industry and for the companies within that industry.

Furthermore, the “Mega Fund” would have their own team of internal traders who could utilize not only all of the electronic trading platforms to receive strong trade execution, but also who could effectively manage their fund’s relationships with a few main trading partners.  Due to the sheer size of these funds, and the total assets being traded, these firms would have the ability to negotiate very cost effective trading fees and have “high touch” relationships with ever trading partners they desired.  This combination of relying on the electronic trading platforms and utilizing relationships with trading partners should alleviate some trading risk for the firm and ensure that costs are properly managed.

Conclusion

As we have seen with the recent changes at some of the largest Hedge Funds, such as Citadel, the “Mega Fund” is here to stay and those professionals at the forefront of this transformation will be able to create tremendous organizations which will have a distinct advantage to many of their smaller competitors.  Besides having a large operational, accounting, and technology platform to support their growth/funds, these “Mega Funds” will have a tremendous amount of internal market knowledge.  If they are able to effectively manage this market knowledge and communicate it efficiently to each of their investment teams these teams will have a distinct advantage over their competitors.

This broad market knowledge can be very useful to a firm if managed properly and can help create tremendous returns as has been shown by Centaurus Energy in the past.