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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
Outsourced CIOs Emerge to Help Structure and Run
More Risk Aligned Investor Portfolios
There is an additional change in the intermediary universe
occurring that is important to note. Many former FoHF
managers or direct allocators have opted to set up firms that
work directly with institutional investors to structure their
overall portfolios and manage that capital on their behalf.
These participants are being deemed outsourced CIOs because
of the function they fulfill. Their emergence is illustrated in
Chart 36.
Our observation from the interviews in this year’s survey is
that for the time being, the outsourced CIO phenomenon is
primarily a US- led innovation. European and some Asian FoHFs
and consultants are often given discretion over all or some an
investor’s capital, but this authority tends to be isolated to just
the hedge fund portion of that investor’s portfolio.
In contrast, the outsourced CIO looks across both the long-only
allocations and the alternative bucket, including the hedge fund
investments. In some instances, these participants will advise
the existing investment team at the investor’s organization
around portfolio construction and manager selection, working
in tandem with these participants in more of an advisory role.
In other instances, the outsourced CIO creates an investment
fund into which institutional investors channel their capital, to
be overseen externally by the outsourced CIO.
In both instances, the outsourced CIO is responsible for
explaining and justifying the portfolio construction and the
manager selection to the investment committee, and to the
board at their client organizations.
One reason that the outsourced CIO model is taking hold is
that the skill set required to shift an investor’s portfolio from
an opportunistic or dedicated alternatives configuration
to a risk-aligned configuration is difficult to obtain for most
institutional investors. CIOs and allocators in the risk-aligned
model must be highly skilled at risk management and able
to measure and reallocate capital actively based on shifting
Fund
of Hedge
Funds
Consultants
ADVICE
TRADING
AUTHORITY
ACCESS
DUE DILIGENCE &
ADMINISTRATION
CHART 44
Managed
Account
Platform
Outsourced
CIOs
Chart 36: Role of Intermediaries in the Hedge
Fund Industry: Emergence of Outsourced CIO
Source: Citi Prime Finance
“ Fund of hedge funds as an access vehicle is no longer a valid
investment thesis. They are justified when they bring due
diligence and other service to the institutional investor.”
– Long-Only and Alternatives-Focused Consultant
“ We are having to change our fees to accommodate
institutional investors. If it is an explicit fee paid out-of-
pocket for advisory services it may need to be lowered to
50-75 bps. But they tend to be OK with a 1.5% fee if it is
charged with the product,”
– European Fund of Fund
“ I definitely see a convergence of fund of funds, consultants,
and outsourced CIOs. Fund of funds could evolve into this.
Investors need to hire the best skill-based people and they
can’t access it via the old fund of fund model,”
– >$10 Billion AUM Hedge Fund