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I
Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
Continuing to refine that story to be best positioned to win
allocations from institutions will be the next challenge that
marketing teams address globally. Our projections, discussed
back in Section III, show that these institutional investors
are likely to increase their allocations substantially over the
next 5 years, and that there could be as much as $1 trillion
in new capital originating from these participants targeted at
managers’ core hedge fund product. Several of the largest
hedge funds have discussed how they are finding success in
attracting this money and the gist of their advice is to adopt a
“know your investor” mindset.
As the range of institutional portfolio configurations expands
and risk-aligned portfolio approaches emerge alongside
opportunistic and dedicated alternative portfolios, hedge
funds marketers need to know how each institutional
investor they are pursuing positions hedge funds within their
broader portfolio, and understand what role those hedge
fund investments are meant to fulfill. Marketers can then
determine the best way to present their own fund to align to
that investor’s specific goals. This concept is illustrated in
Chart 33.
The most successful hedge fund marketing teams discussed
how they perform a reverse type of due diligence on the
investors with whom they meet ,either directly or via those
investors’ intermediaries. The purpose of this examination is
to understand the investor’s specific portfolio configuration
and thus be able to better tailor their marketing message to
most appeal to the investors’ needs.
Each Institutional Portfolio Configuration Requires
Different Selling Points
If the investor has an opportunistic allocation against
which they have broad freedom to select from a variety of
investments, including hedge funds, they are more apt to be
looking for something differentiated about the hedge fund
manager that would make them an interesting addition to
their portfolio. These investors view hedge funds as separate
from their core holdings, and they assess the value/benefit
they may bring to the portfolio individually and on a stand-
alone basis. Hedge funds in this instance are typically
competing not only with their peers, but with a variety of
other illiquid and private equity investment managers for a
share of the allocation.
As such, the hedge fund marketer should stress what is
unique about their approach, their investment team, and
the landscape their strategy focuses upon. Exceptional
returns would be a major selling point for these investors,
much more so than for investors utilizing other portfolio
configurations. Showing how their strategy is uncorrelated
to other investment products outside the hedge fund domain
would also be viewed favorably.
If the investor is looking to fulfill a specific hedge fund
allocation within a defined alternatives bucket, the marketing
team may want to alter their messaging and marketing
approach slightly. These investors will be looking to create
a portfolio of hedge funds, with each manager contributing
a unique profile that will add to that portfolio’s diversity and
stability over a long-term time horizon. These investors
will not be as interested in how the fund compares to other
investment vehicles such as private equity, but will instead be
looking for much more depth on how the manager compares
to other hedge funds.
To that end, the marketing effort should focus on not only how
unique the returns may be, but also on how uncorrelated and
how volatile they could be when compared to other managers
both in your peer group and to managers in other hedge fund
strategies. Investors with this portfolio configuration will want
to hear a clearly articulated view on what market conditions
your fund is most likely and least likely to perform in, and any
actual track record from such periods would be well received.
These investors are also likely to be more focused on
transparency than an investor with an opportunistic portfolio
configuration, so that they are able to gauge whether your
fund is performing in line with the promised profile. During
periods of market turmoil or when there are dramatic swings in
the portfolio, they will also probably require more
communication, so that they understand if there are any
changes occurring in approach.
“ It almost becomes a semantics issue as to whether they put
you in their equities or in their alternatives bucket so long
as you know what you do in their portfolio,”
– Outsourced CIO
“ The first thing we do is try to understand is what they’re
looking for in their portfolio,”
– >$10.0 Billion AUM Hedge Fund
“ I tell people all the time, you need to understand the investor’s
buckets and what they need in their buckets,”
–>$10 Billion AUM Hedge Fund