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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
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Shorting With ETFs or Indices Is Seen as
Unconstrained Long, Not Hedge Fund Product
Many portfolio managers moving from a long-only to a long/
short approach decided that rather than picking individual
stocks to short, they would take on general protection
by shorting relevant indices or ETF products. This was
particularly true of many sector-based long-only managers
moving into long/short product.
Investors and intermediaries comfortable with this approach
cited lower fund costs for trading the short ETF and index
products as opposed to the borrowing fees of the single stock
approach, and also viewed the technique as a learning ground
and stepping stone to moving into more specific single stock
short trades.
It was difficult for many participants, however, to differentiate
between the approach of an unconstrained long fund that was
breaking from the index in terms of tracking and the approach
of a long-only manager using ETFs and indices to express a
short idea.
These participants felt that any fund using an ETF or index to
short was just a rebirth of the 130/30 structure or that this
was an investment approach more appropriately targeted at
retail type investors, and as such should be bundled under a
regulated fund wrapper to correctly characterize the portfolio.
Many investors and intermediaries also noted that portfolio
managers selecting ETF or index product as their preferred
short holdings were not looking to generate alpha on the
short side, but were instead insuring the portfolio against
excessive downside volatility. They felt that this approach
did not warrant the high fee structure hedge fund product
demanded and expressed their wariness about paying alpha
fees for beta product.
Asset Managers May Have to Hire New Talent to
Attract Hedge Fund Flows
The benefit of a long/short mindset is understood at a
theoretical level by many in traditional asset management
organizations, but there have not been many examples of
exceptional managers coming out with product to make an
overwhelming case for the overlap of long-only skills into the
hedge fund universe.
Individual success stories aside, the majority of participants
had doubts about hedge funds originating from long only
organizations and viewed these products as at best “safe”.
Even those in the asset management community noted that
they most frequently targeted a high net worth and family
office audience as opposed to an institutional audience in
marketing their hedge funds. These investors typically have
more familiarity with long only as opposed to hedge fund
managers, and place a value on having a known entity from
a brand name firm being the one to handle their risk capital.
While institutional investors and their intermediaries both
noted that they would be willing to look at talent from any
source, they clearly had biased views about hedge fund
managers originating from the long-only side. For this reason,
many of the asset managers interviewed for the survey
discussed how they have been bringing in resources from the
hedge fund universe to supplement their existing teams or to
create their hedge fund offerings. Portfolio managers and
research teams with this skill set were seen as having a more
solid foundation in pursuing long/short strategies.
“ Being a long-only analyst that will rate something as a
‘sell’ is different than a long/short analyst putting a ‘short’
rating on a stock. Selling a long idea is very different to
actually shorting,”
– Asset Manager With Hedge Fund Offerings
“ Most people, when they first start shorting learn a lot
from their mistakes and I don’t want to pay for that. With
shorting, your biggest mistakes get magnified and your best
ideas get submerged,”
– Outsourced CIO
“ If a long-only guy opened up a hedge fund, we wouldn’t even
look at it. We spend a lot of time with our hedge funds trying
to understand how they approach shorts. We don’t want to
invest in a manager who will use ETFs as shorts. Shorting is
a real skill,”
– Endowment
“ Long-only managers typically can’t short individual stocks
well. 100% long exposure with 40% short exposure via
ETFs is not ahedge fund. The alpha short is important
to us from a research perspective. We consider shorting
ETFs or selling S&P 500 put options as just giving up that
responsibility,”
– Long-Only and Alternatives Consultant
“ The hedge funds we have are effectively long-only funds
because they are only shorting the index. They definitely
came from the long-only side,”
–Insurance Company