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I
Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
This is likely to be the path for many asset managers looking
to expand or create hedge fund offerings in the future.
Proving out their ability to generate alpha in their hedge fund
offerings is likely to be a hurdle these asset management
firms must pass before the benefit of their infrastructure
comes into play for most allocators and their intermediaries
in the institutional space.
More Success May Be Found in Competing for
Lower Fee, Unconstrained Long Funds
There was less clarity from institutional investors and their
intermediaries as to whether long-only or hedge fund
managers were better suited to handle unconstrained long
products in the convergence zone. There is clearly a demand
for more sophisticated and well executed unconstrained long
strategies that do not align to a benchmark, but the jury is still
out on how best to deliver this type of alternative beta and
how best to develop and maintain the right skills to make this
a valuable and viable part of Institutional portfolio allocations.
Asset managers are the dominant players in this space, and
their issuance of these types of ‘hedge fund-lite’ offerings
dwarf the size of their actual hedge fund product. One asset
manager interviewed for the survey that ranked among the
leading firms in the hedge fund space pointed out that its
AUM in these unconstrained long funds was more than five
times higher than its firm’s hedge fund AUM, and that all of the
products emerging from their long-only product structuring
team over the past year had hedge-fund like characteristics.
Fees for this type of alternative beta product emerging
from the asset manager side remain in line with their long-
only offerings. This is likely to be seen as an advantage for
asset managers, since hedge fund managers often look to
charge both a management and an incentive fee on funds
they oversee in unconstrained long portfolios, as will be
discussed shortly.
Asset managers also seem to have a clear distribution
advantage in attracting assets for these types of offerings.
As noted back in Section II, most institutional investors have
separate teams focusing on long-only allocations and on hedge
funds, and the majority of consultants advising institutions
tend to specialize in either long-only or alternative managers.
When the long-only institutional allocator is looking to find
new funds, he and the consultants he employs are likely to
stick with the set of managers they know best—those from
traditional asset management organizations.
How long this edge may last is unclear, however. As will now be
discussed, there are starting to be increased instances of long-
only allocators reaching over the divide in their organization
to request introductions to hedge fund managers so that they
can expand their set of active managers into unconstrained
long funds managed by these participants.
“ I look across both long-only and independent hedge funds.
I try to draw the circle wide. This is a necessity if you want
more experienced teams with a track record,”
– Insurance Company
“ We definitely look at managers coming from the long-only
side. There are many considerations there you have to
weigh. This is a talent business first and foremost so if you
don’t look, you could be missing a real opportunity,”
– Asset Manager With Hedge Fund Offerings
“ We will also work with skilled long-only managers to create
hedge fund products,”
– Long Only and Alternatives-Focused Consultant
“ Hedge funds should and have been successful because
they’re entrepreneurial and their interests are well aligned.
The long-only guys getting into the hedge fund space are
typically safe, but not exciting,”
–Alternatives-Focused Consultant