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Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
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Less Liquid
Convergence
Liquid
Long/Short
Liquidity
Liquid
High
Transparency
Low
Illiquid
Passive Index
& ETF Funds
Unconstrained
Long
Hedged Long &
Actively Managed
Futures & ETFs
Long/Short
Opportunistic
Real Assets &
Long Duration
Benchmarked
Long Only
Chart 5: Product Offerings: 2013 0nward
Source: Citi Investor Services
More Liquid
Private
Equity
A
s
se
t
M
ana
g
ers, Hedge F
u
nds & Priv
a
te Equity
F
ir
m
s
Private Funds
Public Funds
Public & Private Overlap
Private equity firms began to launch their own
versions of less liquid credit hedge funds and of
distressed funds. They also mirrored the hedge fund
trend noted in 2011-2012 to begin to create “cash +
alpha” offerings that featured an alternative trading
fund that in addition to having an ability to realize
gains on the underlying assets also had a revenue
stream associated with those assets that they could
pass back to investors in search of yield. An example
of these new fund offerings can be found in a fund
that invests in railroad freight car leases that increase
in value over time but that also generate monthly
cash streams, part of which is channeled back to
underlying investors each period.
These actions by private equity firms helped to create
a secondary convergence zone in the markets by 2012
as illustrated in Chart 4.
These trends continued to unfold and gain speed in
the last 24 months. The old terminology for the types
of fund offerings became less relevant. Increasingly,
as asset managers, hedge funds and private equity
firms began to offer a full range of different products,
the focus in the market place shifted to the investment
techniques that were used to realize returns in each
type of strategy.
By 2014, with the exception of ETFs, index funds and
benchmarked long-only funds on the liquid end of
the spectrum and pure private equity funds on the
illiquid side, almost all other types of funds can now
be sourced from an asset manager, a hedge fund or a
private equity firm as shown in Chart 5.
Within the convergence zone, investment products
run the full gambit from highly liquid to illiquid, relying
on increasingly complex investment techniques as
they go across that spectrum. These techniques
include holding excess cash reserves, using OTC and
listed derivatives to create and hedge exposures,
shorting securities and ETFs and then obtaining either
margin or repo financing. This move to a broad set
of overlapping products marks the culmination of the
convergence trend of the past decade and lays the
stage for an important new set of supply dynamics in
the coming period.
Market Growth Projections Impact
Supply Considerations
In Part I of this year’s report, we did an in-depth
analysis of expected growth in traditional privately
traded hedge fund 3c-1 and 3c-7 products and in the
expected growth of publically traded alternatives— 40