The flow of capital into hedge funds is becoming an embarrassment for managers because they are running out of enough talented people to invest it.
Hedge fund managers' salary and bonus packages have soared, for the first time topping $1.5 million before any share of profits, according to a survey.
The reason for increases of up to 20 percent is the shortage of talented fund managers, leaving firms struggling to keep up with the inflow of assets, according to headhunter Glocap Search, Institutional Investor News and data provider Lipper HedgeWorld, which commissioned the survey.
Investors poured a record $111 billion into the industry in the first nine months of this year, according to data provider Hedge Fund Research. The inflows took total hedge fund assets to $1.3 trillion. Surveys and anecdotal evidence show more capital is on the way, with some predicting assets will reach $4 trillion over the next 10 years.
Managers' difficulties in finding investment staff could reflect a structural problem in the industry, said Stuart MacDonald, director of alternative investments at Shore Capital, a stockbroking and asset management firm. Talented individuals with an entrepreneurial spirit want to set up on their own, but investors want to give their money to large, established firms.
MacDonald said: "There are a lot of people who seem unable to obtain initial capital or reach a commercial critical mass of assets."
Institutional investors' preference for large firms is so great, it is polarising the hedge fund industry, according to Stu Bohart, head of alternative investments at Morgan Stanley Investment Management. "What will be left will be old-fashioned, single-manager firms led by a dominant person, in the style of Tiger or Soros, and on the other hand new firms that will have $20 billion to $50 billion of assets under management," he said.
Morgan Stanley this month bought minority stakes in Avenue Capital and Lansdowne Partners, which, with assets of $12 billion apiece, are among the world's 20 largest hedge fund managers. It also took control of $6 billion FrontPoint.
Large firms said they were confident they could keep their investors satisfied, even if they expanded. But investors are skeptical. Stephen Oxley, a partner at fund of hedge funds manager Pacific Alternative Asset Management Company, said: "A manager might grow to that size, but would it still be a hedge fund manager? I do not think outperformance is that scaleable."
Large managers admit a shortage of talented managers is a source of concern. They have been forced to employ more managers per $100 million of assets under management to maintain their investment performance as competition grows for a limited number of investment opportunities.
Automation might provide a solution. Marshall Wace, a UK hedge fund manager, has developed Tops, a system for building a portfolio on the basis of brokers' recommendations. Man AHL, the flagship hedge fund of UK-listed manager Man Group, is based on a program that automatically spots trends and orders trades on the back of them.
AHL is one of many hedge funds that call themselves commodities trading advisers, or managed futures funds, and their managers believe they have considerable capacity for growth.
The firms typically invest only 15 percent of their investors' assets, keeping the rest as a buffer to dampen the volatility of their performance. If investors accept longer lock-ins and greater volatility, managed futures firms might be able to handle more assets.
But investors have balked at the volatility of commodities trading advisers' performance. The strategy saw big redemptions during the bull run of the late 1990s when it made sustained losses for its investors.