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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
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Thefirst impact of this change in behaviorwas that institutional
investors became increasingly reliant on consultants. The
role of consultant expanded to the point that these resources
now act as an extension of the institutional allocators’ team in
many organizations. Not only have consultants maintained
their traditional advice-giving role; they are now seen as a
critical “seal of approval” in terms of operational due diligence,
and the “lists” they maintain of approved funds have become
an industry norm in terms of access, literally determining in
many instances which hedge funds the bulk of the institutional
audience is willing to consider for potential allocations.
FoHFs have also significantly repositioned. Fewer investors
were looking to invest in these managers’ co-mingled vehicles
and as such, leading FoHFs responded by deconstructing their
offering. Many chose to leverage the platforms they had
originally created to administer their own fund, and instead
offer that platform directly to investors to use in order to set
up custom funds and administer those funds on their behalf.
This administration could be offered either in the form of fund
of one vehicles or as SMAs.
Leading FoHF managers have also begun to compete with
consultants more directly in the advisory space. These
participants have extensive investment teams that are
experienced at evaluating hedge fund talent, not only in terms
of the safety of those investments but also in terms of their
profit-generating potential. This differentiates FoHFs from
consultants, since consultants do not have any financial stake
in the success or failure of their recommended managers and
FoHFs in contrast are looking to be able to participate if their
recommendations produce positive returns.
FoHFs have also maintained their trading authority, but that
authority is now more tightly linked to the investor. Leading
institutional FoHFs now collaborate more extensively with their
clients around their desired investment profile, exploring many
of the same parameters around their portfolio configurations
discussed in the section above. Rather than offering a single
co-mingled fund, the bulk of FoHF participants are now likely to
have a series of investor-aligned portfolios where they decide
upon allocations jointly with their clients, and different clients
are likely to have decisively different managers in their fund.
Given these changes, it will now often be the investor’s
intermediary that the marketing team engages with in the first
instance, and this intermediary could be coming from either
the consulting or the FoHF space. Yet unlike before the GFC,
the majority of these intermediaries do not have the authority
to act independently of their underlying client, and instead
the marketing relationship becomes layered. Marketing
teams often have to maintain both the intermediary and the
direct allocator relationship.
The final change we will highlight relates to how that
layering may grow even more complex in the coming period.
“ We had a fund of fund before the Lehman shock but
we’re shifting to single funds. After the global financial
crisis our fund of fund did not work well so we’re now
seeking single funds,”
– Asian Corporate Pension
“ Fund of funds could be in real trouble. They’re not dying.
They’re just consolidating into consultants,”
–Outsourced CIO
“ More and more of the foundations and endowments are
moving to the integrated approach. I wouldn’t say it’s quite
up to 50%, but it’s getting up there. They may not be fully
integrated, but they’ve spread their hedge funds out across
2 or 3 major buckets,”
– Alternatives-Focused Consultant
“
r and more we’re seeing people use fund of funds as an
advisor and more and more pensions are going direct. W
saw a $30 million ticket from a cli nt of one of our former
fund of funds. Having old legacy fund of fund relationships
has been very beneficial for us. We’ve raised several million
dollars from this channel,”
– >$10.0 Billion AUM Hedge Fund