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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
Second, asset managers cited hedge fund products as offering
potential to improve their margins. The fee structure on long-
only money has been under pressure from cheaper index and
ETF funds for quite some time, and many active managers
have seen management fees on their assets decline to well
below 1%—and often to as low as 50 basis points. Hedge funds,
with their 2% management fee and 20% incentive fees, were
seen as highly attractive.
Third, the mechanics of how a hedge fund worked appealed
to traditional asset managers, specifically, the ability of
these funds to insist upon a minimal term during which
investors had to agree to leave their money in the fund ,and
the requirement that investors notify the fund manager of
their intent to redeem well before they were able to withdraw
money. These structural aspects of hedge funds were seen
as allowing for more stable portfolios that would enable
managers to pursue more strategic bets in the markets. Even
redemption notification of 30 days and monthly lock-ups were
seen as attractive to these asset managers, as the bulk of
their traditional products offered daily liquidity and investors
were under no obligation to inform the portfolio manager of
their intent to reduce their allocations.
Fourth, there was a talent retention aspect to the decision to
offer hedge funds. Many organizations felt that they needed
to allow senior managers an option to expand their investment
portfolios or risk losing these individuals because they could
strike out on their own to create hedge funds independently.
For many successful long-only portfolio managers, there was
a desire to extend their skill set and challenge themselves to
find extended ways to express their market convictions.
Moreover, the decision was seen as having ripple-through
effects by providing a broader career path for analysts and
more junior portfolio managers who may have otherwise been
drawn over to the hedge fund industry.
Finally, traditional asset managers felt that the cost of
launching and running these hedge funds in addition to their
regulated funds was only incremental, and that they could
leverage their existing infrastructure for the majority of
functions. Unlike actual hedge fundmanagers that had to build
out their infrastructure while simultaneously looking to raise
capital and ensure that they could fund all their operations
off their management fees, portfolio managers employed by
traditional asset managers had substantial proven resources
they could draw upon at limited additional cost, removing one
of the major business concerns institutional investors express
about independent hedge fund managers.
Taken together, these factors have encouraged many
traditional asset managers in the Americas, Europe, and the
Asia Pacific region to launch hedge funds to supplement their
long-only products.
Overlap in Convergence Zone Sets Up Competition
Between Asset Managers and Hedge Funds
The result of these changes has been the emergence of
a convergence zone where investors have the option of
choosing from either a traditional asset manager or a hedge
fund manager to invest their capital. This convergence zone
now runs from regulated long-only funds and long-only
SMAs through to unconstrained long-only funds to regulated
alternative and UCITS funds to directional hedge strategies,
as illustrated previously in Chart 25.
“ Our expansion in to alternatives has mainly been a client-
driven process. Many of our clients are putting more and
more money into alternative products, so it’s a question of
keeping AUM intact and adding net new sales,”
– Asset Manager With Hedge Fund Offerings
“ We view that we are migrating towards a better business
(‘2/20’) and that our competitors (‘regular long/short hedge
funds’) are migrating to a worse lower fee business. Because
we have the infrastructure established it means we can
handle a lower fee model,”
– Asset Manager With Hedge Fund Offerings
“ There is some movement of big long-only managers who are
trying to market their long/short products to me and their
long-only products to other parts of our investment team,”
– European Public Pension
“ When some of the long-only houses were launching their
hedge funds, it was pretty common from the long side to
use shorting the index because it was convenient to get
the product off the ground and learn how to use shorting.
Now we are starting to see their learning curve advance
and many of those participants are starting to do shorting
on a more selective basis—identifying paired shorts or
sector shorts,
– European Insurance Company