Data on hedge fund size

Apart from the theoretical speculations about the size of the hedge fund industry, it is important to see how large the hedge fund industry is in the real world. The data obtained from the data vendors on hedge funds such as Managed Account Reports Inc., Hedge Funds Research, and Van Hedge Fund Advisors indicate that since the mid-1980s hedge fund industry experienced an explosive growth. Because of the problems in hedge fund data,²⁶ there are different estimates of the number of hedge funds. In this section, chronologically reporting the historical growth of the hedge fund industry from different sources of data vendors and academic studies, the size of the industry and its potential for systemic instability will be investigated.

It seems that before 1990s, the growth in the size and the number of hedge funds went unnoticed and captured less regulatory attention. However, since the 1990s, the hedge fund industry

24 United States Securities and Exchange Commission, RegistrationUnder the Advisers Act of Certain Hedge Fund Advisers, 2004), footnote no. 134.

25 These new regulations will be discussed in the fourth chapter of the thesis. It might be argued that the limitations on the number of investors in hedge funds make them very unlikely to be a contributor to systemic risk. However, since every institutional investor can be an investor in a hedge fund, due to their potential huge amounts of investments, it is not practical to limit the risks of hedge funds on the financial system by limiting the number of investors. The regulatory focus should also be on the amount of investments by institutional investors in hedge funds. The relatively loose definition of hedge funds, which was mostly based on the number of investors (at least in the U.S.) and not the size or the concentration of the investment by institutional investors, together with the potentially unlimited leverage capacity might magnify their effects on the financial markets.

26 See Agarwal and Naik, Hedge Funds.

experienced an explosive growth. Chadha and Jansen estimated that 140 hedge funds existed in 1968,²⁷ while Hildebrand reports that in 1990 there were 500 hedge funds managing assets around $40 billion.²⁸

According to Van Hedge Fund Advisors, total number of hedge funds worldwide grew from 1,373 in 1988 to 5.500 in 1997.²⁹ The assets under management (AUM) of hedge funds for the same period of time grew from $42 billion to approximately $300 billion.³⁰ Furthermore, Hedge Funds Research estimates that in 1997 there were 3,000 hedge funds with AUM amounting to

$368 billion.³¹The President’s Working Group on Financial Markets also reported that as of mid-1998 between 2,500 and 3,500 hedge funds existed managing funds “between $200 billion and $300 billion in capital, with approximately $800 billion to $1 trillion in total assets.”³² In the same year, Van Hedge Fund Advisors’ estimate indicates that more than 300 new funds were formed and the total AUM of hedge funds grew to an estimated amount of $311 billion.³³ As of 1999, Goldman Sachs and Financial Risk Management Ltd (FRM) estimate the number of hedge funds to be 3,500.³⁴ In October of the same year, Managed Account Reports estimated the number of hedge funds to be 3,000, and their AUM to be around $205 billion for the year 1999.

As for the same date, Von Hedge estimates that there were approximately 5,800 hedge funds in existence and their AUM was estimated to be about $300 billion.³⁵

In the end of 2001, Stadlmann estimated the total asset positions of the industry to be about $4 trillion.³⁶ Annual Hennessee Hedge Fund Manager Survey estimates that in 2005 there were 8,050 hedge funds with over $1 trillion in assets. This number and the volume of industry shows

27 B. Chadha and A. Jansen, "The Hedge Fund Industry: Structure, Size and Performance," in Hedge Funds and Financial, Dynamics, ed. B. Eichengreen and others (Washington, DC: International Monetary Fund, 1998), 27-41.

28 Philipp M. Hildebrand, "Hedge Funds and Prime Broker Dealers: Steps Towards a “Best Practice Proposal”," in Financial Stability Review; Special Issue, Hedge Funds, ed. Banque de France, 2007), pp. 69-70.

29 As stated earlier, the reader should get used to the anomalies in the data about hedge funds. Some of these anomalies could be explained in terms of different criteria used in the definition of hedge funds in different data sources while others might be because of the arbitrariness in the disclosure of data and also registration by hedge fund managers.

30 Becker, Brandon and Colleen Doherty-Minicozzi, "Hedge Funds in Global Financial Markets," (2000), pp. 6-7.

31 Lois Peltz, "MAR Puts Hedge Fund Asset Base at $205 Billion,".

32 President’s Working Group, Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management

33 Van Hedge, Number of Hedge Funds Increases for Tenth Consecutive Year, September 21, 1999).

34 Goldman Sachs & Co. and Financial Risk Management Ltd., "The Hedge Fund Industry and Absolute Return Funds," The Journal of Alternative Investments 1 (1999), 11-27.

35 Van Hedge, Number of Hedge Funds Increases for Tenth Consecutive Year.

36 M. Stadlmann, Hedge Funds and Absolute Returns (London, UK: WestAM Management, 2001).

a five-fold increase in assets “compared to US $210 billion in 1998 under 3200 managers (and almost a 30-fold rise on the US $35 billion in assets under 880 managers in 1992).”³⁷

Hildebrand estimates that in 2006, there were approximately 9,000 hedge funds with AUM of

$1.4 trillion net of the pool of capital managed by the proprietary trading desks of global investment banks. However, in essence these proprietary trading desks in terms of their activities, strategies, and compensation schemes are no different than hedge funds.³⁸ According to these estimates, compared to 1995, there was a seven-fold increase in the size of the industry.³⁹

Estimates by the Hedge Fund Research (HFR) indicate that hedge fund industry grew from 610 funds in 1990 with the funds under management of $39 billion of assets to 3,873 funds with $490 billion ten years later in 2000.⁴⁰ As Ferguson and Laster suggest, later on, at the end of the third quarter of 2006, there were 9,228 funds managed about $1.4 trillion which represents an annualized asset growth of 19% since 2000. Their report also shows how geographically concentrated the hedge fund industry is. The report indicates that more than $1 trillion of the AUM is managed by the U.S. hedge funds, about $325 billion is managed by European hedge funds, and $115 billion is managed in Asia.⁴¹ In 2008, about 75% of all hedge fund assets were managed by U.S. funds, while around 15% of assets were managed by European hedge funds.⁴² The report also suggests that the industry’s growth was accompanied by the growth in the number of extremely large hedge funds. They demonstrate that at the end of the year 2002, the largest hedge fund had $8 billion in assets, while in 2005 the number of funds having the equal amount of assets grew to 31. This report shows the increasing concentration in hedge fund industry. They report that the asset share of the 100 largest hedge fund managers rose from 54%

in 2003 to 65% in 2005.⁴³ Other studies also confirm the increasing trend towards concentration in the industry. For example, it is reported that in 2008, the 100 largest hedge funds managed

37 Jón Daníelsson, Ashley Taylor and Jean-Pierre Zigrand, "Highwaymen or Heroes: Should Hedge Funds be Regulated? A Survey," Journal of Financial Stability 1, no. 4 (2005), p. 526.

38 Hildebrand, Hedge Funds and Prime Broker Dealers: Steps towards a “Best Practice Proposal”, pp. 69-70.

39 Cole, Feldberg and Lynch, Hedge Funds, Credit Risk Transfer and Financial Stability, p. 8.

40 To see the discrepancies in the number of hedge funds, compare this number with the above mentioned numbers about the size of the industry for almost the same period of time.

41 Ferguson and Laster, Hedge Funds and Systemic Risk, p. 46.

42 Stowell, An Introduction to Investment Banks, Hedge Funds and Private Equity: The New Paradigm, pp. 204.

43 Ferguson and Laster, Hedge Funds and Systemic Risk, p. 46.

74% of all hedge fund assets. In other words, approximately 1.5% of hedge funds managed about 74% of assets. At the beginning of 2011, the largest hedge funds which constitute 5.2% of all hedge funds, managed 62% of all industry’s assets.⁴⁴

As for the spring of 2007, it was estimated that around 9,000 hedge funds controlled assets under management of $1.4 trillion, which accounted for almost 20% of the total value of the U.S. stock exchange. The ISFL July 2008 report shows that the hedge funds’ AUM grew by a compound of 29.4% per year since 1998. This report also estimates that at the end of the year 2007, their AUM accounted for $2.25 trillion.⁴⁵ The Government Accountability Office (GAO) estimates the number of hedge funds at the end of 2007 to be 11,000. The size of assets managed by the U.S.

hedge fund advisers was estimated to be $1.5 trillion.⁴⁶

The most recent estimates of the size of the hedge fund industry in March 2012 indicate that hedge fund industry’s AUM amounts to $2.55 trillion. Citi Prime Finance suggests that in this time span, the estimates of industry’s AUM, depending on the source, ranges from $2.13 to

$2.55 trillion compared to the Q2 2008 peak which ranges from $1.9 to $2.94 trillion.⁴⁷ According to Hedge Fund Research Inc. the hedge fund industry grew from $2.25 trillion in 2012 to $2.63 trillion in 2013.⁴⁸

Despite the rapid growth in the hedge fund industry, compared to other mainstream financial institutions, their mere size is far from systemically important and it is very unlikely that a hedge fund can be considered a SIFI because of its size. For example, between 1999 and 2005, 2,187 hedge funds stopped reporting to major data vendors which is a proxy for hedge fund closure.

However, none of these closures resulted in a systemic crisis or contributed to the financial

44 David Stowell, Investment Banks, Hedge Funds, and Private Equity, 2nd ed. (Waltham, MA: Elsevier, 2013), pp.

226-227.

45 ISFL, Hedge Funds 2008 (London: International Financial Services, July 2008).

46 United States Government Accountability Office (GAO), Hedge Funds: Regulators and Market Participants are Taking Steps to Strengthen Market Discipline, but Continued Attention is Needed. (Washington, DC: 2008) 1-49.

See also Michael R. King and Philip Maier, "Hedge Funds and Financial Stability: Regulating Prime Brokers Will Mitigate Systemic Risks," Journal of Financial Stability 5, no. 3 (2009), p. 285.

47 Citi Prime Finance, Hedge Fund Industry Snapshot, p. 3.

48 See Jesse Solomon, "Hedge Funds Get Bigger as Returns Get Smaller," CNNMoney, sec. Investing, January 22, 2014.

instability.⁴⁹ This limited impact of hedge fund closures and liquidations on financial markets can support the claim that hedge fund’s size is not of systemic importance.⁵⁰

To see why hedge funds are unlikely to become TBTF, it is better to compare the size of the AUM of the global hedge fund industry to that of the banking and the mutual fund industry. As the figure shows below, in 2012, the AUM of the global hedge fund industry was $2.25 trillion.

At the same time, the AUM of the U.S. banks amounted to $14.5 trillion and the AUM of the global mutual fund industry amounted to $23.8 trillion. Therefore, hedge funds’ AUM globally is a tiny fraction of the U.S. banks and global mutual fund industry, and compared with them, hedge funds are hardly to be systemically important. As it will be demonstrated in the next section, the leverage of hedge funds is also significantly lower than the leverage of commercial and investment banks. Therefore, it is very unlikely for hedge funds to become systemically important because of their size.

49 Cole, Feldberg and Lynch, Hedge Funds, Credit Risk Transfer and Financial Stability, pp. 11-12.

50 Ben S. Bernanke, Hedge Funds and Systemic Risk. in: Remarks by Chairman Ben S. Bernanke at the Federal Reserve Bank of Atlanta’s 2006 Financial Markets Conference (Sea Island, Georgia, May 16 2006).