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20 Dec 2007

HFR Says Fewer Hedge Fund Launches in 2007

Hedge fund launches slowed in 2007 for the third year in a row, a sign investors may be putting money into existing funds rather than into new ones with perceived higher risks, according to Chicago-based Hedge Fund Research.

863 funds were launched in the roughly $1.9 trillion industry by the end of the third quarter, compared with 1,518 new funds for all of 2006 and 2,073 launches in 2005. Liquidations also slowed, with 408 funds closing by the third quarter 2007, compared with 717 for 2006 and 848 for 2005, HFR said on Wednesday.

HFR also said that the slowing launches and liquidations in an industry with more than 9,000 funds suggests investors are more inclined to allocate to larger, more established hedge funds, which are likely to be more diversified and have better risk controls.

"In the third quarter of this year, investors allocated nearly 90 percent of new capital to funds with greater than $1 billion already under management," said HFR. "Investor requirements for size and infrastructure may be making it more challenging to launch a new fund."

That contrasts with previous years, when investors often clamored to invest in the latest funds, particularly those founded by high-profile former investment bank proprietary traders.

Private Equity Firms & Hedge Funds May Face Key Man Risk

Despite current investor and media attention on unexpected CEO turnover at major public companies, key man risk, the risk that the departure of a key executive or group of executives will lower credit quality, is more prevalent and a risk to credit quality among private equity firms and hedge funds, says Moody’s Investor Service.

“Recent departures at some large financial companies have brought to the fore the need for effective succession planning and management development, but also highlighted that large firms can usually cope with such departures, however unsettling,” says Moody’s vice-president Janet Holmes. “Hedge funds and private equity firms, however, can face considerably more acute CEO [or founder] leadership transition risk.”

Like other firms with founding CEOs, hedge funds and private equity firms face key man risk because they have often been created by successful founder executives who have played a central role in building a franchise and are closely linked with its business, brand and success. However, unlike most other major companies, these firms face additional key man risk because one or a handful of investors may hold most, if not all, of the voting stock.

Generally speaking, older firms will be more likely to have their equity distributed away from their founder, while private equity firms are less likely than hedge funds to have a single owner.