Hedge funds face growing start-up costs

Legal and compliance costs are putting up barriers to entry and investors are spending more time analysing hedge funds’ risk controls than their investment strategies, according to speakers at a Merrill Lynch hedge fund conference last week.

Managers with less than $200m of assets to run would struggle to meet business expenses, compared with $75m three years ago, said delegates.

Kevin Dunleavy, head of global hedge fund strategy and client relations for Merrill Lynch, said: “Some speakers were saying, ‘I started with $2m or $3m’, and you couldn’t do that today.

“The cost of a compliance officer at a hedge fund has gone up 30% to 40% over the past two years. Even though it looks like regulation is off to the side, no one is going to believe this industry will remain unregulated.”

Dunleavy said Merrill Lynch estimated institutional investors devote between 60% and 70% of their due diligence effort on the infrastructure and internal controls at new hedge funds.

Only about 30% went on questioning investment strategies and performance. The estimates are based on Merrill Lynch’s view of due diligence questionnaires investors give to hedge funds.

Anita Nemes, global head of capital introduction for Merrill Lynch, said: “Institutionalisation comes with higher costs and barriers to entry. You have to have a legal and compliance department.”

Merrill Lynch started a talent management consulting group for hedge funds this year to help them hire staff.

Launches have slowed, according to a recent survey by Absolute Return magazine. Last year’s newcomers had a combined $31bn under management, compared with $34bn for the class of 2005 and $40bn in 2004.

Many of the new funds came from existing managers rather than start-up firms.