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1. Introduction
Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
I
35
Hedge Funds and Asset Managers End 2003-2007
Period at Both Ends of a Barbell
A distinct gap existed between hedge funds and asset
managers after the wave of inflows in 2003 -2007. At one
end of the market were active and passive long-only managers
and managers of long-only separately managed accounts
(SMAs) that offered low-fee, transparent, and highly liquid
portfolios, primarily in the form of regulated fund structures.
At the other end were hedge funds with higher fees, less
transparency, and longer lock-ups. The divide between
these two offerings was so great that for many years, people
referred to the industry as having a “barbell” configuration.
This is illustrated in Chart 22.
This period was one of dynamic growth for the hedge fund
industry, and managers were clearly in a dominant position.
Concerns about capacity were so great that even as the
number of hedge funds grew 66%—from 4,598 funds at
the outset of 2003 to 7,634 funds at the end of 2007 — the
average fund holdings grew even more quickly, rising 80%
from $136 million at the outset of 2003 to $245 million by the
end of 2007. (Source: HFR)
Even more impressive was the growth of fund of fund
intermediaries. Growth in the number of fund of hedge funds
(FoHFs) was explosive. At the outset of 2003, there were
781 FoHFs, and by the end of 2007 that figure had increased
215% to 2,462 funds. (Source: HFR)
Initially, the influx of institutional money into hedge funds came via fund of fund intermediaries, and institutional
investors did not require much transparency into the holdings of underlying managers. This situation changed
significantly post-2008. Hedge fund products, particularly in the more liquid directional and macro strategies,
now offer a profile that is not as far removed from traditional long-only and regulated products. This has
encouraged both asset managers and hedge funds to extend their offerings, the result of which has been the
emergence of a convergence zone where these investment managers compete head-to-head.
Section IV: Investment Managers Respond to the
Shifting Environment
LIQUIDITY
LOW
HIGH
TRANSPARENCY
HIGH
LOW
Regulated Funds & Long Only SMAs
Private Funds
Chart 30
Actively
Managed
Long Only
Funds
Passive Index &
ETF Funds
Directional
Non-Distressed
Absolute Return
Distressed
Hedge Funds
Traditional Asset
Managers
Macro
Barbell
Source: Citi Prime Finance
Chart 22: Investment Structures in the Public Markets: 2007