By Marianne Scordel, founder, Bougeville Consulting – Recent alternative investment surveys have sought to answer the following question: “Investors: Who are they?” Overall, the data shows how hedge funds have become more institutionalised. It also documents how the largest hedge funds are attracting a relatively unchanged level of interest, while investor searches for smaller and mid-sized managers is continuing.
As consultants, Bougeville assists hedge fund managers with their business strategies. This touches upon their decision making and processes as well as how they operate and structure their offering to enhance opportunities with investors. The ultimate objective is always to meet current and future investors’ legitimate expectations or alleviate potential concerns.
The recent surveys prompted us further to explore the split between larger and smaller managers from an investor’s standpoint, and to question the more qualitative aspects of hedge fund investing which will have an impact on allocation in coming quarters. The investors surveyed manage or advise on asset allocation. Sizes at firm level range from USD50 million to over USD600 billion, and hedge fund investments of between USD5 million and USD14 billion. The average size is USD40 billion with hedge fund investments ranging from 2% to 100% of total AUM. Eight investors have worldwide operations, 13 are primarily UK-based or focused, five have their main operations in the EU (outside the UK), while the remaining eight are spread across the Americas, Switzerland and the Middle East (four, three and one respectively).
Large and mid-size managers: Growing interest
With respect to hedge fund investing, three trends are apparent:
Increased demand for emerging managers…
Since the beginning of the financial crisis the banking sector, including the employment market for those involved, has been highly distressed. New managers have flooded in to the hedge fund sector looking to prove their skills and develop a track record as a result of little demand for their services elsewhere. With little to lose, the danger could be that this new breed of managers somehow “pollutes” the pool of investable assets in the alternative space, and raises investors’ suspicion towards all emerging managers – the good and the bad ones. In such a market where there is asymmetric information judging quality is virtually impossible and it is likely that bad managers will drive out the good (viz. the classic “market for lemons” problem found in economics textbooks).
Indeed, one respondent noted that information on past performance is difficult to find, notably due to survivorship bias: “No one quantifies how many start up hedge funds were out there and closed down in the first six months of their existence.” Besides, 22.3% of the respondents reiterated, essentially, that “nobody was ever fired for buying IBM”, highlighting the incentives investors have to “play safe” and avoid emerging managers altogether. Thus, they select big hedge fund brands, knowing that a less than outstanding performance from these managers would not result in them being blamed. Such attitudes are typical in times of fear, uncertainty and doubt, all of which characterise the current environment.
The vast majority of respondents (70%), however, say they have remained favourable to emerging managers. They are either increasing allocations or will do so in the near future. Their thinking incorporates several considerations:
Overall, the 70% of those supportive of emerging funds make for a diverse group. On the other hand, the 22.3% of those who have been rather averse to investing in emerging funds are relatively small in terms of AUM and lack the operational expertise/experience needed for hedge fund investing. This is also the case of those who dedicate only a small part of their otherwise substantial pool of investable assets to this activity.
…but with conditions attached
In spite of this positive picture of the emerging fund space, most of the respondents supportive of smaller hedge funds were quick to nuance their initial endorsement. Yes, they are keen to invest in emerging managers – and, in the case of two respondents, have made a business out of it – but they also point out the following:
Liquid strategies, with CTA and global macro favourite
The respondents who referred to specific strategies pronounced themselves unanimously in favour of Global Macro, with 23% of the overall sample wanting more of this. This is followed by CTAs, as, again, 23% of the overall sample said they wanted to invest more in this strategy in the near future, while only one respondent (4%) wanted to hold relatively less of it.
Reasons for the rebalancing of portfolios in favour of those two strategies had to do essentially with the liquidity offered, and, in the case of macro strategies, the lack of such existing funds available through managed accounts, especially for those focusing on emerging markets.
Credit and fixed income strategies are more evenly split, with 27% of the respondents wanting more and 19% wanting less. While comments mostly referred to product liquidity (or the lack thereof) respondents were equally split among those willing to invest and those reluctant to invest in more controversial products, such as mortgaged-backed securities. Here opinions diverge about the price/value of those products and their current positions in the economic cycle.
Finally, equity long/short strategies triggered the most diverse responses, with 19% of respondents being ‘in favour’ and the exact same number being ‘against’. This result masks a size discrepancy, as the bigger and more institutional investors wanted to invest more, partly because they have recently been underweight or were late comers to investing in hedge funds (e.g. European pension funds).
For an emerging manager, the conclusion to draw from all this is probably to choose your niche carefully and be flawless from a business and operational perspective, knowing that if you are part of the happy few to make the cut, then there are opportunities out there.
Investors want more of…
…and less of
Marianne Scordel founded Bougeville Consulting in 2009 to assist alternative fund managers with their business strategy. This includes providing assistance to hedge fund managers in finding cost effective solutions to compulsory changes (e.g. those pertaining to the regulatory environment) and in enhancing commercial opportunities -- adapting products, structures, or the marketing thereof. Prior to this, she worked for Nomura and for Barclays Capital. She is an Alumna of St. Antony's College, Oxford.