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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
I
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Strategies that are more than 20% net long or short, but less
than 60%, may fall through the cracks in this approach. Indeed,
many investors and consultants mentioned that managers
in this range are hard for them to consider in compiling a
portfolio of single strategies because they do not know how
to evaluate their underlying risks and likely performance in
different types of market scenarios.
The final most frequently mentioned category was macro
funds. Strategies in this bucket include global macro,
commodity trading advisor (CTA)/macro, volatility, and tail risk
strategies. There is some directionality to these strategies,
but that directionality can be obtained from both the long and
the short side with equal ease based on supply and demand
fundamentals as opposed to valuations. Alternatively, these
strategies seek to hedge the investor against certain types
of macro environmental risks such as inflation or periods of
market crisis.
Multi-strategy hedge funds often have sleeves in each of
these buckets and thus cannot be easily classified by their
directionality or neutrality. As such, they tend to not fit
cleanly in any one category. Survey participants indicated
that multi-strategy funds are most often broken out and
placed alongside those strategies they most closely resemble
by investors pursuing this approach.
This move from having a singular hedge fund exposure to
thinking of hedge funds as a varied set of investments has
become more common in the years after the global financial
crisis. The hallmark of this method is that investors are able
to evaluate their portfolios on the underlying risks posed by
each category of hedge funds within their portfolio, and they
can relate those risks to other parts of their broader portfolio
holdings. This has been a critical precursor to broader
changes in investors’ approach.
Investors Begin to Group Directional Hedge Funds
as Part of a Broad Equity Risk Bucket
One of the most commonly discussed changes in many
institutional investors’ portfolio approach, particularly in
the years after the global financial crisis, has been the move
toward aggregating all those strategies that are subject to a
similar underlying exposure to changes in a company’s equity
or credit position, and then looking at that exposure in its
entirety rather than as separate investment pools.
As part of that trend, many institutional investors are
beginning to re-categorize their exposure to directional
hedge funds and combine these allocations with their broader
equity and/or bond allocations. This puts directional hedge
funds into a common category with passive index and ETFs,
with actively managed long-only equity and credit funds, and
in many instances with corporate private equity holdings.
Together, this set of strategies is said to reflect the investor’s
exposure to equity risk. This is illustrated in Chart 7.
This shift in investor thinking about how to configure their
portfolio is gaining traction and was the most commonly
discussed change away from the two main portfolio
configurations discussed at the end of Section I. Even if
investors are not yet reordering their portfolio to align to
this approach, they are considering it as evidenced by the
statements below.
“ The traditional long-only consultants that have moved into
the alternatives space are great as a gatekeeper. They can
see how they can enhance a portfolio and where a fund can
fit. They’re helping to drive this trend toward moving long/
short funds into the equities and fixed-income allocations.
It’s not a massive trend, but an emerging one, particularly
since 2008. When I think about how to structure the fund,
this is definitely something I think about now but it wasn’t
something I thought about 2 years ago,”
– >$10 Billion Hedge Fund
“ Things have changed. Most people put us in alternatives
and in their hedge fund allocation. More and more you hear
people talk about putting us in their equity bucket. Do we see
a lot of people doing that? No, but we definitely see people
thinking about the core exposure they’re taking on,”
– >$10 Billion AUM Hedge Fund
“ We like to understand the exposures we have looking across
all our managers. When we add a manager into the portfolio,
no matter what part of the portfolio, we want to understand
what the impact is on the overall risk. Are we adding more
equity risk when we roll up the portfolio? More credit risk?
We’re moving toward a more risk budget approach,”
– US Public Pension