Planning for Hedge Fund Asset Growth
Continuing our narrative on asset growth, we look back at Seawolf and Bow Street to answer growth concerns.¬†
Once again we return to the question so many mangers face: “How much more capital could you run before style drift occurs?” This can be a difficult question to answer and we have discussed a way to quantify it in a previous post. As a refresher, an emerging manager needs to quell the concerns of investors if they want to grow their asset base because managing $100MM is very different than managing $4B.
Managers can pull three levers to handle asset growth:
- Move up the market cap spectrum
- Increase the number of positions
- Let liquidity deteriorate
Previously, we compiled a chart to describe how liquidity would deteriorate as a portfolio sized up to find at what point a manager would have to consider pulling one or more levers. This helps a manager respond knowledgably to investor concerns and demonstrate a vigilant approach to asset growth. Investors might inquire further about this type of analysis, so we want to dig further into answering this question. Sizing up a portfolio at various AUMs requires the purchase of more shares of each security, as the manager becomes a larger owner of the company, which eventually becomes a constraint on sizing. This is particularly a problem for emerging managers concentrated in small cap names, but a manager can utilize portfolio intelligence to respond confidently to potential investors.
Seawolf Capital and Bow Street Continued
We will examine the same two emerging managers as in our previous article, Seawolf Capital and Bow Street. All the data below comes from 13F public filings, aggregated through our public data product, whereby we collect and aggregate publicly available data. Because we’re using public data, we assume the manager is 100% long, then size up the portfolio from its current market value to various AUM levels, up to $4B. We assume the manager doesn’t pull the first two levers, meaning they don’t move up the market cap spectrum or deploy capital into more ideas, but instead, maintain the current portfolio makeup and allocate new capital to their existing investments. We use 9/30/15 filings for the initial portfolio, and observe how their % of Shares Outstanding changes as AUM increases, keeping everything else status quo.
The chart above shows how Seawolf’s positions change in terms of % of Shares Outstanding as AUM increases. All of Seawolf’s current positions represent less than 5% of a company. At $900MM the first >10% positions enter the portfolio, showing there isn’t a large amount of change in % of ownership of their positions until that point. At $2 billion the fund has over 50% of its portfolio represented in greater than 5% of the Shares Outstanding, emanating from 14 positions. This isn’t a negative sign, but Seawolf, like any manager planning for growth, can use this type of information to address investor concerns about growth by showing the exact impact that growth would have.
The six names below are >10% S.O. at $2 Billon, and are less likely to scale as the capital base grows. Assuming the position sizes stay the same, the % of S.O. must increase for those names:
|Security Name||Symbol||Position Size||% of Shares Outstanding (Current)||% of Shares Outstanding ($2B)|
|FULL CIRCLE CAPITAL CORP||FULL||0.49%||2.69%||14%|
|FIRST NBC BANK HOLDING CO||FNBC||3.26%||1.93%||10%|
|FLY LEASING LTD -ADR||FLY||6.25%||4.50%||23%|
|NET 1 UEPS TECHNOLOGIES INC||UEPS||7.51%||3.79%||19%|
Besides FLY and UEPS, these aren’t large positions for the portfolio, but they require large ownership stakes. Conviction isn’t a problem, and these may be good investments, but now the manager can identify the investments that will limit scalability as they grow. The portfolio can scale up to a $900 MM without changing too much, but the positions listed above won’t be able to stay at these current sizes beyond $900MM. Seawolf must be aware of these limitations to avoid outsized ownership stakes and to effectively deploy capital to other investment opportunities.
Bow Street, similar to the previous blog article’s analysis, shows greater flexibility with their current portfolio. Bow Street’s names can simply absorb more capital from investors. At $3 billion, we see >10% of S.O. representing ~20% of the portfolio, revealing that at this AUM there are positions that cannot scale and may hinder growth ability. At $4 billion it increases to 30% >10% of S.O. Overall, Bow Street can more easily size into its current positions as it grows its portfolio and not worry about capacity constraints both in terms of liquidity and % of Ownership until around $3B.
Even though this scalability exists at the portfolio level, individual positions that become >10% of S.O. limit growth, so let’s dig into them.
|Security Name||Symbol||Position Size||% of Shares Outstanding (Current)||% of Shares Outstanding ($4B)|
|GNC HOLDINGS INC||GNC||9.26%||0.47%||10.78%|
|BERRY PLASTICS GROUP INC||BERY||12.37%||0.60%||13.73%|
|ADAMAS PHARMACEUTICALS INC||ADMS||1.46%||0.83%||18.92%|
|GLOBE SPECIALTY METALS INC||GSM.3||8.24%||1.60%||36.78%|
In comparison to Seawolf, Bow Street has only 4 positions that are >10% of S.O., but these positions are already very large, except for ADMS, and are much larger than Seawolf’s conviction names. In order to maintain the current position sizes, Bow Street would have to become an outsized owner, meaning that as this manager grows they must deploy capital to other names while the positions above decrease in size. Additionally, ADMS is a small position, but maintaining that small size would ultimately require a large ownership stake as well, demonstrating that this position would also have to shrink as Bow Street grows.
Although, on an aggregate level, Bow Street is flexible, they should be aware of potential limitations to more effectively move capital into new investment ideas or increase conviction in current ones. Both examples demonstrate how managers utilize data to address potential investor concerns about capacity, and plan intelligently for growth.
Review the previous post for methodology concerning liquidity assumptions and sizing the portfolios at various AUMs. For this post I took the quantity of shares owned through public filings and what % of the company owned through our internal data set to create Shares Outstanding at present for 9/30/15. Take the current shares and multiply it by an AUM Factor, which is simply the Theoretical AUM/Current AUM. We do this for each theoretical AUM to get how many shares would need to be owned in order to maintain that position size in the portfolio. We then add the % of Portfolio of each position based on its bucket of % of Shares Outstanding and then compile it into chart form for simplicity.
The more we study hedge funds, the more we realize how vast the range of investing styles can be, even within a certain strategy. A manager’s pedigree, personality, habits, and temperament have much more impact than people realize, at times overshadowing the investment process outlined in official fund documents. This is why we started a series of manager profile articles dubbed “Manager Mondays.”
Almost every week for the past three months we chose a manager from our database of thousands of public portfolios and examined their aggregate filings for an in-depth profile and deep-dive investment analysis. A few such articles have been selected by the Novus team as the best of the series.
We hope you enjoy this collection of articles and that it proves valuable to you, whether you’re a fund manager or institutional investor.
Who’s included in the report?
- Tourbillon Capital Partners
- Maverick Capital
- PAR Capital Management
- Glenview Capital Management
- ValueAct Capital
- Gavea Investimentos
- Altimeter Capital Management
Download our latest report to learn more.