Investors increasingly view hedge fund managers in four main categories: All Star; Solution Provider; Small & Mighty; and Run of the Mill. That's according to Ermanno Dal Pont, Director, Capital Solutions at Barclays Capital.
Speaking at a presentation in London on 26 January, Dal Pont noted that Solution Providers are those managers who offer multiple products and tend to be focused on offering bespoke solutions to investors. Performance may not be as strong but the selling point of these managers is to provide solutions.
At the other end of the spectrum are All Star managers, with strong track records and which are often closed or capacity constrained.
“All Star” and Small & Mighty managers focus on generating top performance on a limited amount of products. “Solution Providers” can offer holistic portfolio solutions to their investors across asset classes and are perceived as good partners by investors.
“If you don’t fall into one of these three categories of manager, investors will see you as a Run of the Mill manager and you’re not going to attract many inflows. You need to put in place a strategy to become or be perceived as one of those,” said Dal Pont.
The presentation given by Barclays Capital was based on a research report entitled: What Lies Beneath: 2015 Global Hedge Fund Industry Trends & Investor Allocation Outlook.
The survey was conducted in Q4 2014 by the Strategic Consulting team and canvassed 450 investors with USD6tn in total AuM – and USD1tn collective hedge fund AuM – as well as 40 hedge fund managers across strategies.
From an industry growth perspective, two key points were raised:
1. The share of assets held by the industry’s Top 20 managers has declined from a peak of 30 per cent in 2008 to 24 per cent in 2014: the inference here is that a glass ceiling exists in terms of the ability of managers to get past a certain level of AuM.
2. With respect to strategy evolution, over the last 10 years equity strategies, as a portion of the industry, have shrunk from 42 per cent to 32 per cent, benefiting all other strategies; most notably credit and Fixed Income RV and multi-strategy funds; the latter growing from 13 per cent to 16 per cent.
North American pension funds and private banks are the two largest hedge fund allocators with USD900bn and USD370bn committed respectively. Overall, global institutions account for 60 per cent (USD1.7tn) of the USD2.8tn in industry-wide AuM, whilst private investors account for the other 40 per cent.
Despite a poor year performance-wise, hedge fund assets were still able to grow 15 per cent in 2014, climbing from USD2.5tn to USD2.8tn. According to the Barclays survey, investors who generated the best performance from their hedge fund portfolios were those most happy to take on risk.
Endowments and Foundations (E&Fs), and family offices, enjoyed the highest returns on average. Sixteen per cent of E&Fs had returns over 6 per cent and a Sharpe Ratio greater than 1. By comparison, only 3 per cent of private pensions, with a lower risk threshold, enjoyed the same level of performance.
Much is often made of the fact that hedge fund investors avoid beta exposure as a function of returns as much as possible; understandably given the fees they pay. What is revealing, however, is that private investors, certainly those surveyed by Barclays, have a higher tolerance for beta exposure.
The report found that 88 per cent of private banks and 76 per cent of family offices have a beta tolerance of 0.5 or more. That figure drops to the mid-40s for public and private pension plans. Overall, across all investors surveyed, 64 per cent have a beta tolerance of 0.5 or higher.
“Two thirds of Family offices and E&Fs told us they have no limit in the amount of beta they can have in their hedge fund portfolio, while most pension funds told us they have a limit of either 0.2 or 0.4,” says Dal Pont. “This is generally reflected in their choice of HF strategies in their portfolios: they prefer to allocate to global macro, market neutral and CTA strategies that are generally uncorrelated to equity markets.”
Family offices were found to have the highest (40 per cent) allocation to equity strategies, whilst private banks (27 per cent) and E&Fs (28 per cent) have the highest allocation to macro/CTA strategies.
“Looking at expectations for the year, hedge fund allocators are still positive on their expectations but substantially less so than last year. When we did the survey last year, 45 per cent said they planned to increase their exposure versus 7 per cent who planned to decrease their exposure, yielding a 6.5x ratio. This year, 31 per cent plan to increase versus 13 per cent who plan to decrease, yielding a 2.5x ratio,” said Dal Pont, suggesting that 2015 could witness a bit of a cooling off period.
That said, Barclays still expects 2015 to be an average year in terms of inflows; around USD60bn, of which 55 per cent of net flows are expected to come from institutional investors, primarily pensions.
Finally, the survey results suggest that new inflows could well end up going to fewer of the USD10bn+ managers, 86 per cent of whom now have one or more funds hard closed; particularly in event-driven, credit long/short, fixed income RV and systematic strategies.
Barclays believes this may be seen as a positive development in the industry, potentially leading to greater focus on investments, and ultimately better performance.
“Two thirds of funds that have closed have done so in the past two years after attracting good inflows and reaching capacity constraints. This is causing investors to look elsewhere and is being borne out when you look at net inflows by the size of firm. Between 2010 and 2013, 85 per cent of net inflows went to funds with USD5bn+ whereas in 2014 that figure fell to 53 per cent,” observed Dal Pont.
Moreover, funds with USD1-5bn have seen the percentage of net inflows they attract increase from 6 per cent to 33 per cent.
At the end of Q3 2014, USD5bn+ hedge funds accounted for 67 per cent of industry assets, yet only received 53 per cent of 2014 inflows. Those within the USD1-5bn AuM range, on the other hand, accounted for 23 per cent of industry assets but received 33 per cent of flows.
“This shows a migration by investors down the asset size to allocate to managers within the USD1-5bn range,” said Dal Pont.
