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Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
Asset Managers Extend Product Range to
Protect Market Share
Institutional investors increasingly moved out of
actively managed long-only equity funds in the
years immediately following the Technology Bubble
in 2000-2001, splitting their allocations between
cheaper, passively managed ETF and index funds on
one hand and between hedge fund strategies that
offered an illiquidity premium and alpha opportunity
on the other. This shift in portfolio construction
disproportionately impacted “real money managers”
that specialized in long-only funds that sought to
measure their effectiveness on a relative basis to a
broad industry benchmark. These trends are explored
in depth in Part I of this year’s survey.
Real money managers responded by beginning to
break out of the traditional “barbell” that defined their
product offerings pre-2002. This began 10+ years of
product expansion into funds that are using shorting,
derivatives, margin loans or repo financing to support
their investment strategies. This trend has reshaped
the demand environment and created new uses for
asset owner’s supply as well as new competitors.
The environment prior to this expansion is illustrated
in Chart 1. As shown, prior to 2002, traditional asset
managers offered a set of regulated funds that offered
high transparency and liquidity and for the most part
consisted of benchmarked long-only offerings. At the
opposite side of the barbell were privately offered
hedge fund vehicles that provided little transparency
and long lock-ups on investor liquidity.
In the years before the Global Financial Crisis (GFC),
a number of long-only portfolio managers began
to offer a new investment product that they called
the 130/30 structure. These products, that became
known as extension strategies, allowed an investment
manager to short positions in their portfolio and use
those proceeds to buy an equivalent amount of their
favored long bets.
In that same time period, revisions to the UCITS
regulations allowed traditional asset managers to
begin using derivatives in their portfolios. This gave
rise to the nascent alternative UCITS funds in this
period. Since outright shorting of securities is not
allowed in UCITS vehicles, these new products relied
on swap positions to create hedges on the portfolios
or synthetic exposures to enhance their long-only
returns.
Several traditional asset managers in both the U.S.
and Europe also allowed their favored long-only
portfolio managers to “cross the privately-offered
fund threshold” and launch long-short hedge funds.
This accommodation was made to keep their talent in
house and prevent these managers from going out to
Liquidity
High
High
Transparency
Private Funds
Hedge Funds
Regulated Funds
Low
Low
Passive Index
& ETF Funds
130/30 Funds
Alternative UCITSs
Equity Hedge &
Event-Driven
Equity Long/Short
Relative Value
Distressed
Macro
As
se
t M
a
nager
s
Actively Managed
Long-Only Funds
Chart 2: Investment Structures in the Public Markets: 2003-2007
Source: Citi Investor Services