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Funds of hedge funds must adapt business model to remain competitive, says SEI study

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There are signs of optimism for funds of hedge funds as both investors and managers see the model as resilient and relevant to the long-term investing landscape, despite declining assets and recent negative headlines seeming to signal their decline, according to a study released by SEI.

Nearly three-quarters of investors and consultants polled (72 per cent) believe FoHFs still play a valuable role in institutional investment portfolios, while 84 per cent of those polled believe that FoHFs will exist 20 years from now – assuming they evolve to address growing investor concerns.

The report, titled: "The Evolving Funds of Hedge Funds Model: Seven Ways to Reinvention," reveals the need for FoHFs to adapt to meet evolving investor needs and business challenges, while providing insights to help them remain relevant and competitive.

According to the paper, most investors and consultants believe FoHFs have a window of opportunity to reinvent their business models to address recent dissatisfaction and disconnection with investors, as well as concerns over transparency, liquidity, and fees.

When it comes to fees, more than two-thirds of investors and consultants surveyed (68 per cent) believe they are generally too high for the value delivered.

Despite the concern over fees, increased transparency and liquidity were identified as the most important factors in making FoHFs more competitive by investors and consultants. Managers believe that increased liquidity and a greater ability to generate demonstrable alpha are the most important factors in making FoHFs more competitive.

The study outlines seven areas where FoHFs can achieve the innovation necessary to change investor perspectives and become more resilient and flexible moving forward, including providing greater customisation, more concentrated or specialised portfolios, and completely revamping fee structures.

"While funds of hedge funds have been under pressure for several years, we believe the fund of fund value proposition remains valid," says Philip Masterson, senior vice president and head of business development, Europe, for SEI’s investment manager services division. "If fund of fund managers are willing to innovate and, in particular, offer customised portfolios, there is still a place for funds of hedge funds in investors’ portfolios. We hope this paper helps the industry understand where the opportunities lie for both managers and investors."

The study results suggest that despite recent struggles, many investors still believe FoHFs are a vital resource for specialised advice and expertise unavailable internally. Four in five investors see FoHFs as an ongoing component of their investment portfolios. According to the study, nearly half of investors polled (48 per cent) said the top reason their organisation invests in FoHFs is "to achieve better risk-adjusted returns." The next most cited reasons by investors were "to augment our manager selection capabilities/expertise" (44 per cent) and "to get around small portfolio size and limited organisational resources" (39 per cent).

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