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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
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As shown in Chart 28, the target audience for these regulated
alternative funds is typically retail in nature, although some
institutional investors with conservative liquidity guidelines,
especially in Europe, have also looked at these products to
satisfy their investment mandates. There are also several
macro- or commodity-focused ETFs in this category that have
drawn interest from both a retail and institutional audience.
Fees on these vehicles are typically in the 1% range, and there
are no incentive fees.
There are also a small but growing category of hedge fund
managers that are looking further afield from their current
investor base to create long-only product exclusively targeted
to the retail audience. In many instances, these managers
offer these products on a subadvised basis, charging only a
management fee and no incentive fee on these funds. Most
frequently, they rely on distribution platforms or investment
management partners to distribute and administer these
funds on their behalf. Only a handful of the largest hedge fund
managers create and distribute their own regulated long-only
product. In most instances, there is a 1% management fee
associated with these offerings, but in certain situations, the
manager accepts a lower fee in the 50-75 basis point range to
leave room for their distribution partner to layer on a charge.
In order to better understand the potential growth and industry
wallet for these offerings, we will now take a closer examination
of each, highlighting important nuances in their structures, fee
potential, and the size of their potential asset pool.
Private Equity-Like and Cash + Alpha Products
Focus on Funding Gaps and Infrastructure
Due to the recent poor yield environment and the belief
by many that yields will remain low in the near term, some
investors are taking interest in vehicles and strategies that
generate cash flow as part of their investment and return
expectations. Though these strategies use the traditional
2&20 fee arrangement, most are less liquid than traditional
the managers often agree to wait until the end of the term
or for an extended multiyear period before calculating their
incentive fee.
Most of these strategies emerged to provide alternate funding
options in the wake of the 2008 liquidity crisis in response
to tight credit markets in key areas. Funds designed to take
advantage of the significant yield being offered by bank debt
securities in companies were one of the earliest examples in
this category. These securities are higher in the corporations’
capital structure than traditional bonds and thus considered
safer. They offer floating rates as opposed to the fixed rates
of traditional credit bonds, and thus provide investors an
opportunity to capture rising rates if the environment begins
to shift.
Hedge funds and investors alike saw the opportunity to step
into this market and provide necessary capital that was
traditionally provided by banks. A primary function of the
return for these funds was the coupon (cash flow) provided
by the bank debt instruments. Some distressed hedge
funds alsosaw the opportunity post-2008, and launched
what effectively were short-term private equity funds that
offered limited liquidity and had a set maturity date. Both of
these product types looked to extract value from the market
disruption by offering investors access to corporations and
the cash flows their companies generate.
“ There are a few hedge funds with long-only versions where
they have lower fees than in their co-mingled vehicle. These
fees are still a lot higher than what’s being charged by the
long-only guys, but they’re lower than the hedge fund,”
– Alternatives-Focused Consultant
“ We now have 8 SMAs, 5 of which are long only with about
$4 billion. All of which has been created in the last 5 years,”
– $5-$10 Billion AUM Hedge Fund
“ We need to be entrepreneurial and open to prospects’
demands in order to establish ourselves as a viable business;
some of the products/structures may not be successful, but
it is important to show clients that you are willing to provide
them with product they want.”
– < $1 Billion AUM Hedge Fund