Basic HTML Version
42
I
Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
Methodology
Hedge Fund Offerings Represent Only a Small
Portion of Traditional Asset Manager Product
A select group of asset managers have built substantial hedge
fund businesses in recent years. In several instances, their
hedge fund AUM exceeds $10 billion, making them peers of the
top independent hedge funds managers in the space. Another
wave of newer entrants is also quickly moving forward, and
several have managed to raise more than $1 billion AUM for
their hedge fund products in just the past few years.
Relative to the size of the hedge fund industry, these
are impressive figures and clearly position these asset
manager-backed hedge fund offerings as an alternative to
independently managed funds. Yet, it is important to note
that relative to the asset manager’s total pool of assets;
these figures are quite small, representing less than 5% of
their holdings in most instances.
In part, this is because long-only assets are highly
concentrated in the hands of a relatively small number of
firms. Looking at just the mutual fund market, a subset of
these asset managers’ overall business, ICI found that the
top 25 US firms controlled 73% of the total pool of invested
assets and that the US itself accounted for 49% of global
holdings. Given total US holdings of $11.6 trillion, these ICI
figures imply an average firm size of $339 billion across the
top 25 firms. These figures help to clarify how limited hedge
fund offerings are from this segment.
They also help to illustrate the largest advantage asset
managers have when considering an expansion into the hedge
fund space.
Asset Managers Possess a Structural Advantage
When Offering Hedge Fund Product
By virtue of their size and tenure, traditional asset
management organizations can approach hedge fund product
development with a different mindset —one that is longer
term and less constrained by the daily pressures of managing
a small business. This is an important structural advantage
that runs across the product lifecycle from the inception of
a new fund idea through to the support and maintenance of
established hedge fund units.
The primary difference between asset managers offering
hedge funds and traditional hedge fund managers is the fund-
creation process. Rather than striking out on their own and
looking to create a new fund offering while establishing their
core business infrastructure and ensuring enough day one and
early stage investor capital to keep the organization running,
portfolio managers emerging from the asset management
space have an extremely different path to market.
Portfolio managers launching hedge funds from the asset
manager side begin by pitching their proposed strategy and
approach to peers within the organization, and oftentimes
to relationship management or business development teams
that have ongoing dialog with key clients about their appetite
for new product. If there is interest, the portfolio manager is
typically asked to run a paper portfolio and test the strategy
to understand its eventual capacity and volatility. This testing
can be done on the organization’s existing infrastructure,
allowing the portfolio manager to have insight into the impact
of differing market conditions via their reports and metrics.
Successful ideas are then seeded internally, either by the
organization or with peer capital. The seeded portfolio can
run live for long periods and establish an extensive track
record before being offered externally to clients. The time
pressure typically experienced by smaller firms looking
for fee income is removed, and products can be well
defined and matured before moving into the client domain.
Chart 26 illustrates an example incubation period for a new
hedge fund developed within a traditional asset manager.
In some instances the portfolio manager uses this
incubation period to transition away from running his
long-only portfolio and in other instances, the manager adds
the hedge fund to his existing product portfolio, maintaining
their long-only fund offering.
Asset managers were pushed into a defensive posture by institutional investors diverting funds from their
actively managed portfolios to hedge fund managers. Many market leaders responded by creating their own
hedge fund offerings, leveraging their internal trading talent and superior infrastructure. Some of these efforts
have been quite successful, but in many instances institutional investors and their intermediaries have concerns
about how well long-only investment teams can handle the challenge of long/short funds. An alternative has
been to allow portfolio managers to move away from strict benchmarking and offer more unconstrained long
product with hedge fund-like characteristics.
Section V: Asset Managers Face Challenges in
Extending Their Product Suite