While funds of hedge funds (FoHFs) and investment consultants continue to dominate the industry as conduits for assets, the two propositions are likely to experience greatly different fee pool growth trajectories over the next 18 to 24 months.
These findings are presented in Barclays’ Hedge Fund Consulting team’s latest report, Battle for the Middle.
“Our work has shown that while both these hedge fund intermediaries are seeing margin compression due to price conscious investors, hedge fund consultants have been net beneficiaries of recent market developments,” says Anurag Bhardwaj, Head of Hedge Fund Consulting. “The biggest challenge for both Consultants and FoHFs is investors’ desire for more control of the investment process. This affects FoHFs disproportionately for a multitude of reasons discussed in the report.”
Investment consultants, which serve as a conduit for approximately USD830bn of hedge fund industry assets, operate in a quasi-oligopolistic environment where the industry heavy-weight, Albourne, sets the tone for both services and fees in the industry. With a broadly similar approach towards due diligence and continued fee pressure from investors, consultants may need to either acquire scale to compete effectively in the advisory space or expand into the higher margin discretionary space to differentiate themselves.
Having undergone significant changes in recent years as investors favor more direct investment, the FoHF model will likely be forced to evolve further. Lagging the performance of direct investments for many years, FoHFs are starting to narrow the gap; however, there is continued pressure to cut fees or do more for the same fees, which will be a tough proposition for all but the industry’s largest.
“Battle for the Middle details the significant overlap in the hedge fund intermediary industry,” says Louis Molinari, Head of Capital Solutions. “To stand out from the crowd, FoHFs should play to their strengths and focus on a differentiated value proposition that cannot be delivered by consultants. Consultants, in turn, need to consider whether they are willing to invest the considerable resources required to win higher margin discretionary mandates.”