Hi all,I would like to estimate the maximum capacity for a european equity hedge fund. Is there any standard ways of doing this?I heard that the maximum percentage of daily volume in any stock should be lower than 10% in order not to impact the market. The figure sounds reasonnable but I can't reconciliate that with the observation that HF are often managing $200 millions + and do not seem to struggle (too much). Am I missing something?Any help appreciated

This is a tough question to ask, but at least you have narrowed your focus to a European L/S manager. Even if you try and calculate capacity as 10% of average trading volume, it doesnt speak to how many names are in the portfolio.The trouble with capacity is that its got qualitative aspects as well as quantitative ones. For example, I think the biggest judge of a fund being constrained relates to marginal ideas. There comes a point in time when adding new names to the portfolio and investing more money for "diversification" is no longer justified. Why do many hedge fund managers, especially L/S, experience lower returns as AUM grows? There are a number of reasons, but primarily they are now putting more money in their "nth" - best idea because liquidity constraints dont allow them to simply maintain equal proportions in their best ideas, and simply sitting in cash dilutes returns and upsets the majority of investors who somehow equate being fully invested with optimal returns.You can also pretty much discount any capacity number the PM gives you, because he's earning a nice management fee on that money. With the explosion of HF popularity enabling managers to have absurd fee structures, 2% on $600MM a year doesnt sound so bad.I doubt I've offered you any help answering your question, but my conclusion has been that capacity is directly correlated to new idea flow. The more new ideas a fund can generate the larger the capacity. Some managers dont need more than $150MM, but I know very successful L/S funds with $750MM+ in AUM. The optimal average is probably much less than that.~RQ

In addition to RookieQuant's points, I'd add another reason the 10% of daily volume figure doesn't help you much is you don't know how often they trade or their capital strategy. Some people take $1 of capital and do $100 of daily trades. Other people take $100 of capital and do $1 of daily trades.The 10% figure is not very sensible in the first place. It depends on the stock and the type of trading. If you had to buy 10% of the normal daily volume of most stocks, it would be hard without pushing up the price. But it might be easy to do the same constantly buying and selling relatively small amounts.I don't know of any standard ways to estimate capacity, nor any sensible way to do it without getting into the details of the fund and forming market judgments. I would consider instead the maximum prudent growth rate. Even if the capacity is $1 billion, it is risky to go from $10 million to $1 billion overnight.The only capacity factor I can think of measuring is personnel and systems. If the head trader does everything, the fund may not be able to expand easily. If the analysis is run on Excel, with an assistant trader working on settlement issues after hours, you don't want to pump a lot of new money in.

RQ, Aaronthanks for the answers. It's basically what I was hoping forNo clear cut answer but some clues about what to look at

Fund capacity is how large a fund can grow whilst still meeting its objectives.EQ International combines its quantitative expertise and depth of market analysis to determine the fund capacity of fund managers and their individual funds.Seven capacity factors are assessed:1. fund objectives2. historical performance3. investment style4. regulatory restrictions5. fund restrictions6. market restrictions7. manager restrictionsBased on these factors the fund capacity of any fund or funds within a fund managers stable is determined.Contact me for further details.

I run a L/S fund. Typically the way I address the capacity issue is based on the following:1. The number of stocks in the Universe. 2. The number of shares of each stock traded per day. The maximum possible size of each trade should be taken into account and compared against the average number of shares traded per day. Also use the median of the shares traded rather than the mean.3. The mechanism and cost of trading. This is a good judge of the scalability of the portfolio. The first point also relates to the alpha potential of the strategy. If the results are based on highly liquid names then one can assume that the strategy is scalable and their is less of a chance of the alpha disappearing as the AUM grows.