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I
Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
Methodology
S cti n VI: Hedge Funds Reposition to Capture New Opportunities
Largest Fund Managers Are Most Active Pursuing
New Product Innovation
Investors and their intermediaries interviewed for the survey
also had concerns about hedge funds moving into the
convergence zone and offering long-only, unconstrained long,
or regulated alternative products, but these concerns were not
tied to their investment skills. Rather, concerns were linked to
perceptions that these managers were “asset gathering” and
shifting their focus away from their core hedge fund product.
This has to do with the fact that it is often the largest hedge
funds with AUM near, at, or above $10 billion that are the most
public participants pursuing this product diversification.
These largest hedge funds are the ones with the most
established infrastructure and developed product teams
and, as such, are typically the most active in developing new
offerings. These new products can incrementally add to their
margins and can oftentimes be created at extremely low cost.
Many of these new products are focused in the convergence
zone highlighted back in Section IV. As will be discussed, some
of the emerging products from these largest hedge funds are
also targeting a different convergence zone that overlaps with
the private equity space.
While these are the most recognized hedge funds offering
convergence product, these are, however, another category
of managers that are also active in this space but whose
participation is not as widely publicized. This is illustrated in
Chart 27.
The number of large hedge fund managers with $5 billion or more AUM is growing, and as these organizations
mature they are exploring expanded product opportunities. For some managers, their ability to continue raising
assets in their core hedge fund offerings becomes constrained above a certain level because of short-side capac-
ity concerns. Other managers have extensive sunk infrastructure costs and are looking to enhance their margins
and leverage their trading expertise by creating new products that offer investors cash + alpha, or that target
new audiences. Determining the right course comes down to a manager’s willingness to trade off high fees for
larger asset pools.
Appetite to Manage Institutional Allocations
LOW
HIGH
<$1 B
$1 B-$5 B
$5 B-$10 B
$10 B+
Chart 35
Hedge Fund Manager Size
Size Concerns
Institutional Threshold
“Direct
Allocator
Sweet Spot”
Concern About
Managers
Limiting Capacity
Concern About
Ability to Generate Alpha
Opportunity
Zone
Source: Citi Prime Finance
Chart 27: Managers Best Positioned to Consider Product Innovation